Final Outline for Oil and Gas Law

Oil & Gas Law – Prof HartSpring 2009

I) Introduction1. Terms: not for final…

Porosity- ratio of the pore volume to the total rock. (If there is any oil or gas it will reside in the pore spaces.) So, no porosity, then no oil & gas formation. 10% to 20% is usually adequate for an oil reservoir.

Permeability- ability of a material to transmit fluids. Ten to one hundred millidarcies (md) is adequate for an oil reservoir and less is required for gas.

a) Organic Theory: the generally accepted theory on how Oil & gas accumulates(1) Oil comes from decomposed plants and animals that lived in the seas and nearby lands(2) Pressure transformed layers into oil/gas(3) Primary migration into porous rocks(4) Secondary migration into rock where oil & gas are found today

b) Four things to form an oil & gas field:(1) A source of carbon and Hydrogen(2) Conditions which caused the decay of decomposition of these remains(3) A porous Rock or series of such rocks(4) A local structure or trap

c) Two types of Classifications of Oil & Gas Reservoirs(1) Geologic type - there must be a trap then there can be 1. a dome shape or 2. anticlinal (a dome that is

longer and more narrow) or 3. fault trap (layers of earth crust have slipped and trapped the oil & gas.(2) Energy type - this is the type of energy used to move the oil & gas from the reservoir out of the ground.

The types are 1. Solution Gas Drives (the least effective) 2. A gas cap drive (uses the solution and there is free gas on top of the oil) (much better recoveries of 25-50%) 3. Water drive (uses the solution and a bunch of salt water on top of the oil) (this is the very best and helps recover 30-70% of the oil).

2. Drilling a Wella) See notes if needed

3. Land Description:a) For final: need to be able to create a plat and describe a given piece of landb) Section numbering: For a given township, remember that you number the sections starting in the northeast

corner, and then proceed in serpentine fashion, 1 through 36(1) Township – adjoining contiguous tracts of land (6 miles square)(2) Section – 1 mile square (640 acres) 36 within each township

(i) Correction Sections – some sections will not have exactly 640 acres. Corrections are made on the North (1-6) and West (6-31) sections.

c) To describe a portion of land, count how many township lines north or south of the baseline and how many rangelines east or west of the principal meridian the land is. That forms the township description for the land: for ex, T2N, R3E IM (township 2 north, range three east, Indian Meridian).

d) Now, to describe a portion of land in a section within that township, work from the smallest fraction and go forward: for ex, describe the southwest ¼ of the southwest ¼ of section 2, T2N, R3E, IM.

4. Law of Capturea) Hard Rock

(1) At Common Law - the person who owns the surface owns the property down into the earth and up to the skies.

(2) Congress passed statute for federal mining claim or federal lands – can mine all veins even if they extend underground beneath the neighboring land.

b) Transient minerals (O&G):(1) Rule of Capture – The owner of the mineral estate is entitled to extract all the oil and gas that can be

produced from a well bottomed on his estate no matter where the oil or gas comes from (even if the O/G bearing formation extends beyond the land of the surface owner) Kelly v. Ohio Co. Subject to correlative rights doctrine and conservation regulations.(i) Exceptions

Page 1 of 34Railroad Commission: Regulates oil and gas industry

(a) Not committing waste (b) Not negligent(c) Follows conservation laws.

(ii) Limitations(a) Common law limitations

1. Nuisance2. Negligence

(b) State Regulation - States wants to preserve natural resources and avoid waste1. Spacing and density requirements (# of wells on a tract) 2. Production limits (# of barrels)

(2) Examples: (i) An example of the rule of capture: Say you have two adjacent landowners (Sam and Alice). Sam

sinks a well and drains oil from a formation that runs under both surface tracts. Sam takes in 5000 barrels, 2000 of which came from under his land, and 3000 of which came from under Alice’s land. Remember, that under the law of capture, this fact doesn’t affect Sam’s right of ownership in the oil – it is still all his, even though some of it ostensibly came from Alice’s property.

(ii) The rule of capture has limits, though. Remember that in the case of horizontal drift, should the well bottom under someone else’s land, then the rule of capture does not apply; instead, the well is held to be in trespass, and the oil and gas is held to be the property of the owner of the surface (no matter if you can show what proportion of oil and gas came from each person’s land). See note 2 on p. 13 of text.

5. Theories of Ownership (little emphasis put on theories in class)a) Ownership in place (ownership) – Landowner owns all substances, including O&G, which underlie his land.

Such ownership is qualified, in the case of O&G, by the operation of the law of capture. If the O&G depart from beneath the owned land, ownership in such substances is lost. TEXAS RULE

b) Exclusive right to take (nonowership) – Landowner does not own the O&G which underlie his land. He merely has the exclusive right to capture such substances by operations on his land. (1) Once reduced to dominion and control, such substances become the object of absolute ownership, but

until capture, the property right is described as an exclusive right to capture. Can drill on your land only if you have the exclusive right to take it. OKLAHOMA RULE

6. Ownership Prior To and At Extractiona) Del Monte Mining & Milling

(1) Minerals are part of realty until they are extracted. O&G. Once you take the oil out of the ground it is personal property.

(2) Owns everything up and down. No limit. From the heavens to depths. Entitled to extract whatever is underneath the property as long as it does not extend to someone else’s property. Else liable for conversion.

7. Benefits of lessee v Owner in extracting minerals(1) Owner - Owns the surface and minerals. If he drills land he bears costs of drilling the land. He also gets

profit. If dry hole, then out of costs. (2) Lessee – L owns mineral estate subject to right he owes to surface owner (O). Typically L needs to

subtract royalty fees. Landowner has no obligation to pay expenses. If L drills a dry hole (no oil or gas), O is not out anything.

8. Ownership of Extracted O&G(1) Oil

(i) Champlin Exploration v. Western Bridge & Steel Co. - Oils leaks out of tank and permeates to the surface and ground. Owner tries to take back the oil. Owner of mineral estate sues. Argument was that once he flowed back to land it was realty not personal property. Oil owner entitled to get back oil.

(ii) RULE: Once personal property, always personal property, unless it is abandoned. Owner may lose possession but he still retains title.

(2) Gas: what about natural gas that has been re-injected into the ground for off-season storage?(i) RULE: as long as the party storing the gas retains control of it, then it remains theirs.

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(ii) Texas American Energy v. Citizens Fidelity (KY case) - Underground storage tanks. Banks wanted security interest in oil(a) Injection of natural gas back into the ground for a natural storage well. Here the court says that

the natural gas does not loose its personal property characteristics when stored on a well defined area. If gas escapes underground storage, it is treated as abandoned because you cannot identify it from any other gas.

(3) Who has the right to lease such storage capacity? surface or mineral owner?(i) OK RULE: If there was no mention of conveying storage capacity, then we presume the surface

owner kept everything he did not convey(ii) Ellis v. Arkansas Lousiana Gas Co. (OK) - Court found that the surface owner had the right over

storage and thus the defendants (mineral rights owners) had no right to grant the gas company no right to store the gas. Judge looks to:(a) Parties intent - Examine the conveyance of the mineral interest if you are dealing with a severed

interest – see if it says anything about who retains control over the storage capacity (b) Hard Rock mining law

1. English view – mineral interest owner2. American View – surface owner

a. Consistency would lead to this same view for oil & gas, thus surface owner would own the porous spaces after first emptied.

(c) Policy reasons – mineral interests can be very fractionalized while surface owners will be easier to find and obtain permission from.

(iii) As a practical matter – GET PERMISSION FROM BOTH!

9. Conduct Permitted in Extractive Process a) People’s Gas Co v. Tyner (IN)

(1) Nuisance Limitation - You cannot use mineral estate in such a way that creates a nuisance/injury to adjoining land.

b) Wronski v. Sun Oil Co(1) Sun intentionally overproduced the area in excess of the mandatory drilling and spacing units.

(i) B/c they overproduced they are liable to the other owners for the oil that cam from under their land(ii) B/c they did it intentionally they are not allowed to deduct the cost of production

(2) Fair Share Principle(i) Rule of capture is alive and well, but it is subject to conservation regulations

(a) Not Self-executing – only operates under established conservation regulations. You can bring a suit to enforce conservation regulations, but you cannot just bring a suit b/c you don’t think you are getting your fair share.

(3) Correlative rights – Rights and duties of all landowners in the common source of supply. (i) Kuntz - owners of land overlying a common source of supply stand in a peculiar position to one

another b/c production by one will have an effect on the economics of another. Each has the right to produce from the common supply without accounting to the other. However, each owner has a duty to take into account the similar rights of the other owners.

(ii) Duties of Correlative Rights(a) Not to waste Eliff v. Exxon – Rule of capture does not apply to wasting oil & gas.(b) Not to spoil (as in not to spoil surrounding freshwater reserves)(c) Comply with valid conservation regulation – Sun Oil (exceeding the allowables) Neighbor

sued saying his correlative rights were being violated. 1. Royalty owners have the same standing to sue

(iii) Common Source of Supply - an underground reservoir, all parts of which are permeably connected so as to permit the migration of oil or gas or both from one portion thereof to another wherever and whenever pressure differentials are created as a result of the production of oil or gas from said producing formation.

(iv) “Correlative rights” - refers to all the rights and duties among such owners in relation to a common source of supply.(a) If no common source then RR commission regs don’t apply.

(4) Doctrine of negligence - Applies to operator or equipment. Correlative rights doctrine protects owners from negligent or wasteful operations that injure or destroy the common source of supply.

10. Types of O&G Interestsa) Fee interest – Totality of all private rights in the land. Surface and subsurface rights. “owning the entire

bundle of sticks”b) Mineral interests – the mineral interest can be severed from the fee estate by grant or by reservation.

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(i) By grant, the original owner of the property could convey the ownership of the mineral estate. (ii) By reservation, the property itself could be conveyed, with the conveyor reserving the mineral estate

to himself. (2) Incidents – A common formulation divides the mineral interest into four incidents:

(i) The right to use the surface – Owner of a mineral interest owns the mineral rights described in the conveyance together with an easement to use the surface and subsurface as reasonably necessary to explore for, develop, and produce the minerals. (a) Even if easement is not expressed in the severance instrument, it will be implied. (b) Mineral estate owner has the dominant estate so it has an implied easement.

(ii) Right to incur cost and retain profits (right to develop)(a) Working/Operating interest – One who has the rights to use the surface to incur costs, and to

retain profits (Cost bearer, profit taker)(b) Net profits interest – an owner who has only a right to share in the profits of an operation.(c) Carried (nonparticipating working) interest – No sharing of costs.

(iii) Right to Alienate(a) A mineral interest if freely alienable. The right to alienate is commonly called the Executive

Right. (b) A transfer may be in the form of a mineral deed, a royalty deed, or a mineral lease

1. Oil and Gas Leases: Distinctions between Oklahoma and Texas a. In Texas, where there is ownership in place theory - a lessee has a fee simple

determinable estate in the mineral estate, and the lessor now has a possibility of reverter.

b. In Oklahoma, where we don’t have the ownership in place theory, but instead have the exclusive right to take theory. The leasehold estate is considered to be a license or a profit a Prendre.

(iv) Right to retain lease benefits: Some other lease definitions(a) Bonus: the amount of money paid to the lessor up front(b) Delay rentals clause: provides that during the course of the primary term, periodic payments

will be made to keep lease viable.(c) Shut-in gas clause: provides that periodic payments will be made when gas may be physically

producible but because of other factors, (such as lack of market) it cannot be sold.(d) Royalty: lessor’s portion of the revenues from the sale of oil and gas produced on the property.

It is a “cost-free” revenue – the oil company bears the expense of producing the oil and gas1. Term: duration of oil and gas lease, typically three years, but often with indefinite

extension (“for so long after the initial term as oil and gas is produced from the premises”).(e) Working Interest: interest held by oil producer to work the well, incur costs, and realize

revenues in the production of the oil (3) Some rights implicit in the oil and gas lease (even if they are not explicitly provided for in the oil and

gas lease)(i) Make such use of the surface as is reasonably necessary (such as installing tank batteries, reserve

pits, )(ii) Do so at such locations as are reasonably necessary (even if that happens to be in the middle of a

wheat field)(iii) To use and consume the surface or its products (examples: drilling a water well, drilling a salt-water

injection well, using a previously drilled dry hole)(4) Countervailing limits on implicit rights

(i) No “excessive use”(ii) Observe accommodation doctrine(iii) Exclusivity of use of surface (can only use the surface for the benefit of operations on that land, not

for the support of operations on other parcels)(iv) Observe applicable statutes and regulations(v) Observe lease provisions

(5) Forms(i) Fractional (ii) Interest in certain minerals (iii) Fractional part of certain minerals

1. Royalty interest – Owner of interest entitled only to a share of production as expressed in the instrument that creates the royalty interest. Has no right to use the surface, no right nor obligation to incur costs, and no right to share profits.

(b) Nonparticipating royalties – ie. Conveying or reserving ¼ royalty interest.(c) Landowner’s royalty – Lessor’s reserved royalty.

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(d) Overriding royalty – O&G lessee may assign the lease reserving royalty. 1. Term interests – Mineral interests with determinable durations.

11. Drilling and Spacing Units / Poolinga) HOW: Created by the Oklahoma Corporation Commission

(1) OCC, upon proper application and notice, has the power to establish well spacing and drilling units of specified and approximately uniform size and shape covering any common source of supply… 52 § 87.1(a)

(2) Any person owning an interest in the minerals in lands embraced within a common source of supply or the right to drill a well for o/g has standing to petition for pooling. 52 § 87.1(a)

(3) Forced Pooling: when owners have not agreed to pool, and one owner has drilled or proposed to drill, the Comm (to avoid unnecessary wells), upon proper application can require owners to pool and develop their lands in the spacing unit as a unit. 52 § 87.1(e)(i) All order requiring such pooling shall be made after notice and hearing, and will be upon such terms

and conditions as are just and reasonable and afford to the owner of such tract in the unit the opportunity to recover or receive without unnecessary expense his just and fair share of the o/g.

b) WHY? (other states have similar statutes, but stick with OK TX is different)(1) Purpose

(a) Conservation – prevent more wells than are needed being drilled to the same common source of supply.

(b) Even if we have enough wells, there can still be a “crowding” problem to close together(2) How accomplished

(a) Keep from having too many wells by adhering to the “1 well per unit” theory.(b) Too close to the line – handled by the commission dictating where the well can be located.

(3) Size(a) 80 large, 40 small – unit where expected Oil produce (based on expectations)(b) if we’re wrong, statute is written where we can get back in and correct.(c) 160 up to 640 – for gas – why? With gas, one well will adequately drain a large area

(4) Where – regs dictate location(a) ex. 640 acre – can place well in the 160 acre square in the middle (legal location)… can apply

for an exception(5) Exception – might need to move if the center 160 isn’t over the common source of supply.

(a) Must ask commission for permission, but will likely add a “penalty” or “restriction” – if they don’t, you could have uneven drainage (screwing the next unit out of their gas (if they have a disproportionate coverage)

(6) Change – The commission can NOT modify its prior order establishing a drilling and spacing unit without a change in technical knowledge

(a) Change in technical knowledge - encompasses an acquisition of additional data or the discovery of new scientific or tech knowledge requiring a re-evaluation of the geographic opinion. 2 kinds of changes: 1. Internal change of condition – actual change of physical conditions in the formation2. External change of condition – physical behavior constant – original conclusion of the

geologists and petroleum engineers turns out to be inaccurate b/c of new technical knowledge

(b) El Paso Co. v OCC - If changing conditions show that the spacing units as established won’t drain the well then: 1. Make more units - Comm could “de-space” and then “re-space” depending on the behavior

and conditions of the source.2. Could also “increase density” but leave the spacing in tact.

(c) Phillips Petro: change in actual knowledge of the parties was not a change in technical knowledge and was a prohibited collateral attack.

(d) Calvert Drilling: where drilling would determine configuration of prospective common source, and where records confirmed presence of established common source over 75% of requested spacing unit, Comm had power to extend drilling and spacing unit to encompass land overlying edge of the common source.

(7) Legal effect – Communitizes the royalty interest in the unit.(a) Unit with 4 owners and 4 lessee’s, one lessee drill’s the well… the other three owners get their

proportional share of their royalty… they would each get ¼ of the 1/8th royalty (if ownership is equal among 4 owners)

(8) Well spacing Exceptions:(a) Offset well – when you drill a well to protect your correlative rights

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(b) Types of exception locations – where location was permitted to prevent drainage.(c) Permitted on a tract too small to be a drilling unit/meet minimum distance requirements.

1. Meredith v. OCC – bringing in of a new well did not require re-spacing and application did not deny a landowner of due process… a. fact that well proved to be exception (because it produced gas when it was classified as

an oil well) did not compel a change in the spacing… any other holding would require constant changing in spacing.

II) Federal Environmental Regulations1. Three types of Fed Environmental laws with potential impact to O&G1 (any given statute can have more than one

type)a) land use restrictions – how you can and can’t use your landb) performance standards – maybe not as applicable to oil and gas extractions, but these limit the amount of

pollutants that may be emitted by an operationc) clean-up liability – like CERCLA and RCRA, these impose cleanup liability on certain parties to remediate

environmental problems that already exist. 2. Upstream activities (Obtaining the Oil & Gas Lease) – What Fed Environmental laws should an oil company

take into account before looking to drill?(1) Two laws that often affect oil and gas production are the Clean Water Act (specifically its wetlands

provision) and the Endangered Species Act (specifically its “take” provisions). b) Clean Water Act “wet lands” (Same definition under the OPA)

(1) §404. Must get a permit from US army corp of engineers if going to deposit fill material on to a “wet land” if it is a wet land adjacent to waters of the US (navigable river, tributaries)2

(a) Bayview Homes – Navigable waters means “waters of the United States” which includes tributaries connected to a source of surface water that could affect IC, wetlands adjacent to any such tributary, and even nonnavigable INTRAstate waters whose use or nonuse could affect IC

(b) Solid Waste Agency: Here, the Supreme Court dealt with the migratory bird rule, and struck it down. (Limited the reach of CWA into italicized lang above) Arguably, the court established the “adjacent” rule – that for a water to properly come within the authority of §404, it has to be adjacent to a tributary of a navigable stream or adjacent to the navigable stream itself.

(ii) Obtaining a Permit: Once the required “nexus” with “waters of the US” is established, the next step is to determine whether a “pollutant” is being discharged.(a) Water, gas, and other substances used for injection drilling purposes are not pollutants under the

CWA (may have to get a state permit however.) (b) The type of permit is going to be based on where the discharge point is: (onshore, offshore,

coastal) and how much effluent limitations will be placed on the dumping.1. Ex. Onshore operations are allowed no discharge into “waters of the US.”

(iii) Safe Drinking Water Act: protection of groundwater by monitoring maximum contaminant levels or “MCLs”: General rule is don’t inject near drinking water; get a permit for to be sure.

(2) §311(f) – Clean up liability under the CWA.(i) Imposes liability on the “Owner or Operator” of the property at the time the discharge is discovered

(a) NOT talking about PRPs – talking about ‘owner or operator’(b) NOT talking about discharging onto land – taling about discharge of ‘pollutants’ into waters of

the US. (c) NOT hazardous substances – talking about pollutants

(3) CWA prohibits the dischare of a pollutant unless you have a NPDES permit how much and how often you can discharge into the water(i) Two kinds of permits:

(a) Individual permit – by application and covers a single discharging facility(b) General Permit – specifies a procedure for a class of applicants to become subject to the general

permit. Many have been issued for activities covered by Oil & gas industryc) Endangered Species Act

(1) Sweet Home Ch: Definition of “take” in the Endangered Species Act – the statutory definition of “take” includes the word “harm.” And the regulations promulgated under the Act define “harm” to mean “an act which actually kills or injures wildlife. Such act may include significant habitat modification” (i) The Court construed the word harm in the ESA broadly to include indirect as well as direct harm.

1 Single statute can impose all three types of regulations2 Fed cannot regulate isolated wetlands

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(ii) The Court determined that the regulation was appropriate, noting that under the regulation, modification of the habitat does have to result in the killing or harming of the wildlife (i.e. there has to be some actual harm). (a) Ex. if the construction of the road and the drill site might significantly impact the habitat of the

bird, and may actually cause harm to the species, then there is cause for concern on the part of the oil company. However, if the habitat is determined to be a quarter section, and the road and site take only a handful of acres, then there might be some doubt, since the requirement is that there be a significant impact on the habitat of the species.3

(iii) Hypo – in TX and there’s a little bird on an endangered species list… want to build a road into the lease site… don’t even know about it…(a) what if this modification of the environment is going to interfere with the bird?

a. We need from Sec of Interior an incidental “take” permit if what we are doing is going to kill/disrupt the bird.

d) Clean-up Liability – CERCLA4 (superfund law)(1) Imposes liability where a hazardous substance is found on or under a tract of land

(i) substance must be one that might present an imminent and substantial danger to public heath or welfare or environment (environment expands liability)(a) Need to determine what is a hazardous substance - there are lists of hazardous substances. (b) No quantitative requirement! – any amount of the substance will result in liability.

(2) To Prove a CERCLA Claim the party trying to impose liability or receive contribution would have to show: (i) That the site in question is a “facility” under CERCLA(ii) That the Defendant is a potentially responsible party: PRP list includes:

(a) current owners(b) current operators(c) owners when hazardous substance was disposed(d) operators when substance was disposed(e) parties that created the substance and arranged for the transportation, disposal, or treatment.(f) Parties who did the above for another party(g) Parties who selected where the waste was taken(h) Intermediate owners ONLY if they obtained actual knowledge of the release or threatened

release when they owned the property and then sold it without disclosing such knowledge(iii) That a release occurred of a “hazardous substance” (no quantitative requirements for such a

release) Release is pretty much defined as: any dumping, emitting, leaking, abandoning, or disposing of any kind.

(iv) Important: (tricky): This release has to have caused you to incur clean up costs: in the Amoco v. Borden case this meant that the material had to be classified as something that needed to be cleaned up or something that you have to act to contain. i.e., another statute or local reg. might have to impose a standard on the PRP or the clean up party that makes them clean up the waste. The most stringent standard will be followed. This is some form of quantitative requirement b/c your cleaning it up must be justified/reasonable b/c you were required to clean it up b/c of a statute.

1. Not a matter of culpability a. CERCLA scheme isn’t necessarily geared toward finding fault, but just making

someone responsible for cleanup. Liability based on status of party, NOT FAULT…b. Gov can sue you for clean up costsc. Or Innocent 3rd Party can sue you for contributiond. Factors Considered in Damage Amount:1) you get what is necessary and

consistent w/NCP (, 2) Ct. considers: transportation costs, treatment costs, storage costs, disposal costs, price paid for the facility and any discounts offered on the land b/c of the contamination.

(3) CERCLA’s “Petroleum Exclusion” (yes, RCRA has one too!)(i) “Does not include crude oil or any fraction thereof,” “does not include natural gas in gas or liquid

form”

3 Note that the burden is on the developer to assess whether their use of the land will impact the endangered species.

4 Key to statute is who it designates as “Potentially Responsible Parties” aka… PRP’sPage 7 of 34

(a) Cose v. Getty Oil Co (9th Cir. 1993): P Wanted to recover response costs for cleaning up “crude oil tank bottoms” (Solid sediments & produced water with high levels of chryosene) Issue is whether “crude oil tank bottoms” constitute a “hazardous substance” or whether they fall w/in CERCLA 9601(14) “petroleum exclusion”

(b) Must prove 9607(a)(4) that a “release” of “threatened release” of a “hazardous substance” from the facility as defined in 9601(9) has occurred. Exclusion: Petroleum, including crude oil or any fraction thereof which is not otherwise specifically listed or designated as a hazardous substance under subparagraphs (A) through (F)

(c) COA: P contend that the Oil Tank Bottoms are not petroleum or fractions, D contends that they are!1. Petro could have Hazardous Substance in it if the substance is at greater concentration levels

than naturally occur in petro.(d) Analysis: Ct determines that OTB are not petro or frac…under CERCLA

- OTB are not seperable by fractionation- Never subjected to refining processes- Not used for producing useful products- U.S. v. Western Processing: cites a case that found OTB sludge to be contaminated waste

product (case is distinguishable because it came from lead tanks) but case did give substantial deference to EPA definition of “petro” and the EPA construction of the stat and its remedial nature

- Wastes Distinguishable from “recyclables” - Petro storage vs. waste depositing

3. The Solid Waste Disposal Act (SWDA): SWDA consists of several solid waste management programs, the most extensive of which is RCRA, to regulate hazardous wastes. Under it, EPA was charged with the responsibility of forming lists of what would be considered hazardous wastes. a) Drilling waste – Mud and salt water, chemicals, etc… these are exempt from being qualified as “hazardous

waste” under RCRA Oil co caught a break(1) RULE of thumb: anything that has come up the well bore is not a hazardous waste. That’s not to say that

they are not solid waste under subtitle D, though. b) Wastes exempt under Subtitle C are nevertheless Waste and could still be found to be an “imminent hazard”

and subject to EPA cleanup liability.(1) Note that if the EPA considers a substance an “imminent hazard” then something that may be otherwise

exempted might still get pulled back into being a “hazardous waste.”(2) Meghrig: Here’s the deal, kids: RCRA 6972 doesn’t provide a private cause of action for prior costs of

cleaning up toxic waste that doesn’t (at the time of the suit) continue to pose an endangerment to health or the environment. Don’t clean up first, or you’ll get screwed with your pants on…

(3) RCRA: is reduce the generation of hazardous waste, impose the requirements as to how and what and what limitations should exist as to cleaning up current and future contaminations.

(4) CERCLA: is to deal with an already created problem and impose liability on past contributors.

III) The O&G Lease1. Introduction.

a) Leases are both conveyances and contracts. File the O&G lease with the court(1) Conveyance – It is the instrument by which the mineral owner conveys a right to an oil company to

explore for and produce oil and gas, reserving a royalty interest in production. Lease creates a fee simple conveyance. An outright conveyance of minerals. Terminates automatically if certain conditions are not satisfied. Terminates on a limitation not on a condition. Lessor retains a possibility of reverter.

(2) Contract – Oil company accepts the right to explore and produce, burdened by certain express and implied promises.

(3) Leases are executed like deeds, by lessor not by lessee. Lessor’s signature is either acknowledged before a notary public or subscrived by witnesses and recorded in the county real property records.

(4) Lessors are generally paid a bonus for executing the lease. (5) Disclosure of economic information- Reluctance to show too much of the lease since that would allow

others to know how much the bonus was. Don’t want to file lease but they want other to know there is a conveyance. Instead a short document called a Memorandum is filed, indicating that –or –ee have an agreement.

b) Purpose of the Lease(1) Goal of the lessee

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(i) Primary Term - Seeks the right to develop the leased land for the agreed term without any obligation to develop; and (There are no certainties of success until the lessee takes the risk of drilling a well. Whether taking that risk will make sense for the lessee depends on economic factors)

(ii) Secondary Term - If production is obtained, the lessee wants the right to maintain the lease for as long as it is profitable. (lasts indefinitely because an oil company cannot predict how long a lease will produce profitably.)

c) Nature of the Leasehold Interest(1) Distinctions between Oklahoma and Texas

(a) In Texas, where there is ownership in place theory - a lessee has a fee simple determinable estate in the mineral estate, and the lessor now has a possibility of reverter.

(b) In Oklahoma, where we don’t have the ownership in place theory, but instead have the exclusive right to take theory. The leasehold estate is considered to be a license or a profit a Prendre.

(2) Some other lease definitions(a) Bonus: the amount of money paid to the lessor up front(b) Term: duration of oil and gas lease, typically three years, but often with indefinite extension

(“for so long after the initial term as oil and gas is produced from the premises”). (c) Delay rentals clause: provides that during the course of the primary term, periodic payments

will be made to keep lease viable.(d) Shut-in gas clause: provides that periodic payments will be made when gas may be physically

producible but because of other factors, (such as lack of market) it cannot be sold.(e) Royalty: lessor’s portion of the revenues from the sale of oil and gas produced on the property.

It is a “cost-free” revenue – the oil company bears the expense of producing the oil and gas(f) Working interest: interest held by oil producer to work the well, incur costs, and realize

revenues in the production of the oil

d) Surface Uses Granted By the Lease(1) Dominant estate owner can do whatever they want as long as it is reasonably necessary to explore,

develop, and transport the minerals. They cannot be negligent. The dominant estate owner must have due regard for the rights of the surface owner and is required to exercise that degree of care and use which is a just consideration for the rights of the surface owner. (i) Reason: Dominant estate has an implied easement. Without such rights, the mineral estate would be

worthless and meaningless.(2) If you are the surface owner you would put surface protects provisions when severing the land.(3) Not required to fix the place after they are done. (4) Accommodation doctrine (Getty Oil) – If there is only one manner of use of the surface whereby the

minerals can be produced, the lessee has the right to pursue this use, regardless of surface damage. (i) Where there is an existing use by the surface owner which would otherwise be precluded or

impaired, and where under the established practices in the industry there are alternatives available to the lessee whereby the mineral can be recovered, the rules of reasonable usage of the surface may require the adoption of an alternative by the lessee(a) This is NOT a balancing test! Surface owner ONLY wins IF the legitimate objective of the oil

company can be achieved in another way(ii) Requirements to invoke doctrine

(a) There must be an existing use of the surface(b) The mineral lessee’s proposed use of the surface must preclude or impair the existing use of the

surface; and(c) The mineral lessee must have a reasonable alternative available

(iii) Limitation – Under Whitaker, the doctrine is limited to situations in which there are reasonable alternative methods that may be employed by the lessee on the leased premises to accomplish the purposes of the lease.

(5) Implied Rights: Lessee may generally exercise these rights without the lessor’s permission, with no obligation to compensate for surface damage and no obligation to restore the premises.

(a) The right to use and occupy the surface of the land for purposes reasonably necessary to develop and operate the lease. Includes right to build storage tanks, power stations, and structures upon the leased land to produce, store, and take care of production. 1. Hunt Oil: [H] the oil co were not required to show their proposed activities were the most

reasonable or even that other alternatives were unreasonable in the absence of the P bringing the reasonableness of other alternative into issue.

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(b) The right to use and occupy the surface of the land at such locations as are reasonably necessary (even if that happens to be in the middle of a wheat field)

(c) To use and consume the surface or its products (examples: drilling a water well, drilling a salt-water injection well, using a previously drilled dry hole)

(6) Countervailing limits on implicit rights(a) The mineral interest owner or lessee may make only such use of the surface as is reasonable

necessary to produce oil and gas. 1. Remedies - You can get an injunction and damages.

(b) The use of the land must not violate the accommodation doctrine (c) The surface use must be related exclusively to obtaining the minerals under the servient surface.

Lessee may not use the surface of the lased land to develop or haul production from the lands of others.

(d) The application of the state’s police power, state statutes, city ordinances, and governmental regulations may limit the easement rights of the mineral owner or lessee.

(e) Lease clauses may curtail the rights of use of the mineral owner or mineral lessee. (7) Cherokee Water Co. v. Forderhause: execution of an oil and gas lease is a ‘sale’ for purposes of a first

right of refusal by grantor when conveying the property to a third party.(8) Hinds v. Phillips Petrol: Except as may be limited by the terms of the lease, leasehold interests are freely

alienable under OK law either in part or in whole. (i) Thus oil company could transfer to a third party the right to lay pipeline across the premises for the

purpose of transporting out oil produced on the land(9) Remedies against the lessee

(a) Lease cancellation(b) Damages

(10) Remedies against the lessor for denying the right to use the surface(a) Interfering lessor is liable for consequential damages to the lessee. (b) State statutes might provide treble damages(c) In junction, damages(d) Obstruction doctrine – A lessor who obstructs the lessee either by denying access to the

property or by attacking the lessee’s title is precluded from denying the continued validity of the lease. Ordinarily, obstruction tolls the running of the lease primary term. If it occurs at the end of the primary term, the court may extend it by for a reasonable period.

IV) The Oklahoma Surface Damage Act (§ 318.3 et seq.)1. Provisions of the Surface Damage Act

(1) Lessee has to give written notice to the landowner, including where the well will be drilled, how much land will be required, and when operations will begin

(2) Lessee must post a bond(3) Lessee has to engage in good-faith efforts to arrive at an agreement for surface damages before heavy

equipment is moved in (negotiations have to begin within 5 days of this notice)(4) If the negotiations cannot come to a settlement for damages, then we go to the appraisal process; petition

must be filed with district court in county where land is located. (a) Landowner appoints one appraiser, oil and gas lessee appoints one appraiser, and the two

appraisers then together appoint a third. These appraisers have to evaluate the damage that has occurred and will occur, and then file a report with the clerk of the court.

(b) If the report isn’t satisfactory, the parties can file for exceptions, and the judge can make exceptions sua sponte

(c) If that still doesn’t do the trick, then the parties can file for a jury trial1. If the jury’s award is less favorable than the appraisal report, then you have to pay the other

side’s attorney’s fees2. Even though the Surface Damage Act was in conflict with some of the implicit rights under the common law, it

supercedes. Santa Fe Minerals. Davis Oil Co. v. Cloud – all damages are to be considered in making the appraisal, not just excessive use of the land.

3. Function of the appraisers (Dyco case)(1) The appraisers are supposed to determine the diminution of the FMV of the land has occurred and is

going to occur as a result of the oil company’s occupation of the surface; personal inconvenience may only come in when it affects the value of the land.

(2) It is ok to consider the diminution in value of the parcel beyond the land actually taken if the oil and gas production efforts have a direct impact on the entire parcel (Consider a well on a farm where there was 8 acres in drill site, but that affected the use of an irrigation system that serviced the entire 160 acres)

(3) Appraisers are allowed to consider damages that have occurred or that will occur

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(4) OSDA does not contain any provisions for prejudgment interest, and unless prejudgment interest is allowed by statute, it is not to be granted.

(5) Once a damages award has been determined in favor of the landowner, it is inappropriate to condition the receipt of that award on the posting of a bond or other security.

4. OSDA claim can be tried in the same case as a tort claim for the same acts, However, the procedural tracts must remain distinct throughout the entire proceeding. Ward Petroleum Corp.

5. OSDA doesn’t apply to exploration damages (seismic work) b/c the SDA refers only to drilling operations. Anschutz

6. Timing of filing the petition in court if agreement on damages cannot be reached: Sanford says before you move in with heavy equipment, if you haven’t already arrived at a damage agreement with the surface owner, then you have to have filed a petition in the district court – the petition has to be filed before entering

V) Lessee’s Use of Groundwater:1. Under the Groundwater Act – must apply to OK water resources board to get a permit to use water

a) Exception – Owner (Surface owner) can take from his own land for domestic use w/out obtaining a permit2. OWRB won’t issue groundwater use permits to an applicant who does not own the land on which the well is to be

located, or hold a valid water lease from the owner of such land permitting the withdrawal of water from such basin.

3. Since the effective date of the amendments to the Water Act, an oil and gas lessee has to have a water lease from the surface owner in order to use groundwater. a) Ricks – Water Resource Board’s holding that only surface owners could apply for a water permit was an

unconstitutional taking b/c common law gave lessee right to use water for purposes of leaseb) 1985 - Legislature quickly changed statute after Ricks to say that only Surface Owners could give permission.

Thus Oil & Gas lessee must get water permit from Surface Owner c) Unit Petroleum Co. – Statute change above may only operate PROSPECTIVELY. Lessee’s who acquired

their interest before amendments in 1985 need not obtain a water permit before seeking a permit from the Board

VI) Calculating damages to the land:1. Schneberger teaches us that the appropriate measure of damages is based on whether the damages to the land are

temporary or permanent(1) If damages are permanent, then damages are diminution in value (difference in FMV of the land w/o the

contamination v. with the contamination).(2) If damages are temporary, then damages are cost of remediation. However, if cost of remediation is

grossly disproportionate from the diminution in value, then that diminution becomes the measure of damages.

VII)Substances Granted By the Lease - Important to clearly identify the minerals. Granting clause also changes certain powers to alter the surface. Legislation has changed the rules where the term “other minerals” is used in the lease. 1. Lands and Interests Granted By the Lease – When property is not described by reference to a government

survey, lease drafters use the metes and bounds system which locates property by establishing its exterior boundary lines by referring to natural or artificial monuments and directs and distances.

2. Protective terms – Because land descriptions may be inaccurate and titles uncertain, leases often have protective terms.

1. In-gross warranty – Gross acres specified will be deemed correct whether it is more or less. Lease is for the gross acreage described rather than being calculated on a per acre basis. Protects the lessee against lease failure if it turns out that the lease inaccurately describes the # of acres in the property.

2. Mother Hubbard – Used when prop description is likely to inaccurately locate boundaries. Provides that the lease is intended to cover all of the land owned by the lessor in the area. Shouldn’t put it in. Might cover property not intended to be leased if you have contiguous property.

3. After-acquired title – crazy idea. Covers land now owned by lessor or hereafter acquired which adjoins the land described.

4. Proportionate reduction clause – so the lessee doesn’t have to pay bonuses to 2 different people. Permits lessee to reduce lease benefits to the extent that the lessor owns less than the full mineral interest described. This proportionate reduction clause also applies to reduce lease benefits to the lessor by the amount of outstanding nonparticipating royalty interests.

5. Subrogation clause – Empowers the lessee to protect its interest by paying taxes or mortgages encumbering the property and then stepping into the shoes of the former creditor.

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Limitation - Failure to comply automatically terminates the lease.

*Claim default of the lessor when arguing against a limitation

“Forfeiture” is a condition subsequent. Forfeiture is not automatically. Someone must take action to forfeiture. The other party has the right to come up with equitable defenses.

6. Warranty clause – Not a general warranty. Creates only a covenant of warranty, a promise to defend the lessee against future lawful claims and demands. There is no breach until the lessee is physically or constructively ousted from the property. a. No warranty of title - Warranty of title gets you nothing until someone comes along

and ejects you. Giving them the right to quiet possessionb. Remedy – If there is failure of title, lessee may recovery damages from the lessor.

VIII) Habendum Clause: Maintaining the Lease During the Primary Term1. Primary Term - Fixed number of years during which the lessee has the right, without any obligation, to explore

for oil and gas or to drill for oil and gas on the premises.a) Implied covenant to develop and drill a test well - Implied covenant to drill a test hole in every lease. This

is why we have delayed rental provision. Absent a delayed rental provision to delay the breach of the covenant, the lease is terminated. (1) When you have a delay rental clause, If you breach covenant the remedy is damages not forfeiture.

b) Maintaining the lease by paying delay rental - Delayed rental paid during the primary term on the anniversary of the effective date of the lease(1) Delay rentals – Allows the lessee to extend the lease from period to period during the primary term

without drilling, by paying delay rentals. (i) Remember, delay rental terms can only keep the lease alive during the primary term; after that, (i.e.,

once you are in the secondary term of the lease) if you want to extend the lease without re-executing it, you have to have drilled and be producing the well. In essence, the delay rental clause creates a special limitation on the duration of the primary term.

(ii) Remember, in both OK and TX, failure to pay delay rentals on time does not result in forfeiture – it results in the termination of the lease.

(2) Schwartzenberger v. Hunt Trust Estate(i) Net mineral acres = your % of mineral ownership times surface ownership(ii) “Unless” term – special limitation by which interest of lessee terminates immediately, w/o notice,

upon failure to pay rentals or commence drilling. Only applies once it has been extended past the primary term. For example: lease will last for 3 years unless oil and gas are produced in paying quantities [and remember that delay rental clauses are often structured to create a legal fiction of production].

1. Note the strictness with which the “unless” term is often interpreted: If you don’t either drill or pay in the correct amount at the correct time to the correct people, the lease automatically terminates.

2. Mailbox rule on delay rentals: Note that in our “Standard” lease form, there is a mailbox rule provision – payment is deemed made when it is placed in the US Mail.

(b) The lessee had the duty to check the county records to determine the proper amount of acres subject to the lease… cannot just rely on what the owner thought the deal was. This is an application of Humble below (distinguished from that case b/c there lessee made a good faith mistake and here lessee did not fulfill duty required)

(c) Humble case - Lease was signed. ¾ mineral interest. Ottos assigned away a portion of their minerals to someone else. 1. ½ of the minerals has 2 different meanings

a. 1] “in land conveyed” 50% of the mineralsb. 2] “in land described” 3/8 of overall mineralsc. Key is that the ambiguity arose after the lease was signed. d. Holding: Where the lessee in good faith made a mistaken construction of the lessors’

partial conveyance of their interests and lessee has made a payment in accordance with such construction, of which the assignee has notice, the duty rests on the assignee to notify the lessee of its mistake so that the lessee will have an opportunity to make a proper payment of the delay rentals. Where assignee instead of giving lessee such notice, remains silent, Ct holds that the assignee is estopped from asserting that the lease has terminated as to his interest on the ground that the lessee has failed to pay him a sufficiently large share of the delay rentals.

(iii) Failure to meet these requirements will result in loss of the lease. Payment:(a) In the proper amount (b) On or before the due date

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1. Tendering rental to the proper party but at an improper address, results in termination of the lease if the rental does not reach the lessor before the due date. Use of an incorrect address invalidates the payment.

2. EXCLUDE THE DAY THE LEASE IS EXECUTED IN CONSIDERING WHEN THE YEAR ENDS.

(c) To the proper persons(d) In the proper manner

(iv) “Unless” Exceptions: (a) Equity has been invoked to preserve leases with unless clauses. A jurisdiction that treats

termination of the lease due to noncompliance as a forfeiture may apply equitable principles to prevent loss of the lease. On the other hand if it views it as a limitation, they would technically be precluded from using equitable principles to prevent loss of the lease.1. Failure of an independent third party beyond the control of the lessee.

a. i.e. PO mis-delivers properly and timely mailed payment.b. Unless there is a provision that mailing is sufficient this will not bail you out

2. Lessor’s acceptance of a late or inadequate tender of delay rental. If the lessor accepts a late or inadequate payment, some courts may hold that estoppel or waiver prevents the lessor from asserting termination of the lease. Other cases hold that a lessor’s acceptance of an inadequate delay rental payment continues the lease as to the number of acres for which payment was adequate.

3. Knowledge – If lessor knows that payment is late and that the lease is thus terminated, but cashes the late delay rental payment anyway. If lessor does not know it, then lease did not terminate.

4. Confusion or ambiguity caused by the lessor after the lease was executed. 5. Lessor’s failure to notify lessee of mistake in payment – Where lessor knows that the

lessee has made a mistake in paying payments, some cts have held that the lease continues in effect unless the lessor notifies the lessee of his mistake. a. KUNTZ’s idea on a basic statement of exception to the unless clause: “the event which

will result in a termination of the lease is not simply a failure to drill or to pay delay rentals in strict compliance with the lease, but is a failure to do so which may be attributed to the lessee’s fault or dereliction and is not attributable to circumstances beyond the lessee’s control.”

(3) Doctrine of Revivor – An interest that has terminated may be revived if the parties to the lease act as if it were still valid. Both parties act as if it were still valid, ct may accept it as being valid.

(4) Separate ownership clause – Designed to protect lessee after a partial assignment. Normally, where a lessee assigns an interest covering a separate portion of the tract leased, the failure of either the assignee or the assignor to pay delay rentals on that portion of the lease will ordinarily cause termination of the entire lease. A separate ownership clause is intended to change that result.

(5) Surrender clause – Permits the lessee to surrender the lease to the extent that it covers land thought to be unproductive. Allows someone to takes a large tract of land. Gives them the right to release some acres and not pay the delayed rental. Rental payment will be reduced in the proportion that the acreage covered is reduced by. Effect is that you can find someone else to pay you bonus on the land

(6) Savings clause – clauses designed to prevent the automatic termination of the lease upon failure to timely pay proper delay rentals.

(7) Paid-up leases: not only will lessee pay the up front bonus money, but they will also pay an additional sum that basically represents a payment of the delay rentals in advance. Pay all in advance so you won’t have a problem if delay rentals are not paid properly

(8) Alternative “or” – Use “or” instead of “unless” so lease does not automatically terminate upon a failure to pay rental or commence drilling. This clause would impose a duty to commence drilling, pay rentals, or surrender the lease before the anniversary date.

c) Meaning of “Commencement”(1) Majority Rule – A lessee has commenced a well if operations have been conducted on the land in good

faith preparation for the drilling of a well for oil or gas and has continued the operations in good faith and with due diligence. Does not require actual drilling. Taking a surveyor out is sufficient. After that you have to, in good faith, complete the process by drilling. Breaux v. Apache Oil Co.(i) Bear in mind, though, that some courts read the language of the lease very precisely, and if the lease

says that you have to have “commenced to drill the well” then the bit does have to have pierced the earth.

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(ii) KUNTZ: Factors which have been considered in determining whether or not a well has been commenced include the factors of :(a) Acts on the premises(b) Good faith of the lessee(c) Diligence in continuing drilling operations.

(iii) Doctrine of obstruction: When you can’t commence because some jackass is preventing you from doing it.

1. The doctrine of obstruction acts to preserve the lease if the lessor in some way prevents the lessee from fulfilling his end of the deal, and grants a reasonable time extension to the lessee

2. Oklahoma courts say that this doctrine can be applied even if the obstructer is not the lessor but instead is the severed surface owner).

2. Habendum Clause: Extension and Maintenance of the Lease in the Secondary Terma) Production “In Paying Quantities” – If a well pays a profit, even small, over operating expenses, it

produces in paying quantities, though it may never repay its costs, and the enterprise as a whole may prove unprofitable. (1) TEXAS RULE: Clifton v. Koontz - Must have production in paying quantities. IF no to step 1 and 2, then

lease terminates(i) Step 1: Is there an operating profit?

(a) Time frame for determining production is usually at least one year. We are interested in the daily operating costs for a year.1. Examples of expenses that are NOT included

a. Sunk costs, i.e. costs incurred in drilling the well b. district office expenses (basically, the district-level administrative expenses)c. general administrative overheadd. Depreciation of casing, tubing, and Christmas tree because such items aren’t related to

the lifting of the oil from the well; again, we go back to the idea of “lifting costs” 2. The share of production attributable to overriding royalty interests paid to third parties is

NOT taken into account in calculating operating income. Overriding royalties, like drilling costs, are part of the capital investment, not part of operating costs. HOWEVER, a royalty interest to the lessor IS included in operating costs. Hininger v. Kaiser (OK).a. Overriding Royalty – Typically created when the person who takes the lease (lessee)

assigns the lease to someone else and he will retain or reserve an overriding royalty. As long as the original contractual interest (to lessor) is sufficient we do not subtract other royalty interest.

(ii) Step 2: If there is no profit then we have a subjective test. Standard: Would a reasonably prudent operator, for the purpose of making profit and not merely for speculation, continue to operate a well at a loss?(a) The lessor has the burden of proof.

(2) OKLAHOMA – step 1 appears to be dispositive…(i) However, that does not necessarily mean the lease will be forfeited. Cort will look at equitable

considerations to see if there was any compelling equitable reason for keeping the well going – if yes, the still have “paying quantities” (similar to prudent operator)

b) Actual Production or Capability of Production?(1) Stanolind Oil & Gas Co v. Barnhill: TEXAS – ACTUAL PRODUCTION

[H] under the circumstances of the case, though gas was discovered, the lack of market during the essential lease time prevented the lessee from meeting the definition of “producing”… therefore the lease expired on its own terms. (i) In TX must be discovered, extracted, and marketed for the lease to continue.

(a) For gas you cannot store it anyway. In order to market it you must get it to a pipeline. (2) Shut-in Royalty - Applies to gas only. If a lease terminates at the end of the primary term and there is no

production, you need a “shut-in royalty” clause. Is a savings clause that keeps the lease alive while the gas is being marketed. Constructive production. If you do not have this clause then you are out of luck if the lease is expiring soon and you don’t have a ready market.

(3) Pack v. Santa Fe – OKLAHOMA – CAPABLE OF PRODUCTION(i) Oklahoma’s “capable of production in paying quantities” rule: well has to be capable of producing

(doesn’t have to actually be bringing oil up the wellbore); doesn’t have to be actual production; capability will satisfy the habendum clause. (a) However, remember that such production must be obtainable by just “flipping on the switch” –

if one has to refit or engage in extensive repairs to get production, then that won’t cut it.

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Anadarko says: a well that will produce in paying quantities if the well is turned on and it begins flowing without additional equipment or repair.

(b) Texas doesn’t play by this rule; in TX, you have to have the actual extraction of oil and gas, PLUS facilities that let you connect to a pipeline or otherwise transport the produced oil and gas.

(4) 3 different interpretations of “production” (i) Discovery of O or G will satisfy habendum clause (OK, WV)(ii) Discovery of gas is sufficient, but if oil is discovered the oil must be actually extracted in order to

satisfy the habendum clause. (MT, WY, KY)(iii) Discovery and extraction for gas marketing (LA, TX, NM, KS)

(5) Implied covenant to market (i) No matter which view of production is adhered to, the lessee is also subject to an implied covenant to

market lease production within a reasonable time after discovery and at a reasonable price.

c) Savings Clauses as Substitutes for “Production” – Savings clauses address the circumstances that commonly prevent a lessee from, obtaining or maintaining production. All of these clauses may be thought of as providing substitutes for production or constructive production. (1) Temporary Cessation Clause :

(i) Pack v. Santa Fe Minerals (Okla. 1994): Emphasizes that capability of production, and not marketing, is at the essence of satisfying the habendum clause. More importantly, though, this case tells us that the capability doctrine that governs the habendum clause also governs the cessation of production clause – the well must be incapable of producing for the 60-day period; just ceasing to bring oil and gas up the wellbore for the period may not trigger the termination of the lease.

(ii) Bachler v. Rosenthal (Tex 1990) (total cessation have to act, regardless of capability) After the primary term had already ended, there was a short complete cessation of production, but thereafter reworking operations took place and production was restored. In this case, the court noted that whereas in Clifton there was a profitability issue that stopped production, here there was a total physical stoppage of production. In such cases, they have to do something within the 60 day period or lose the lease.

(iii) Anadarko Petroleum Corp v. Thompson (TX): Law was well established in TX that it requires extraction… but this lease used the words “can be produced.” (Unusual in TX)… Ct said to follow the language of the lease and thus no forfeiture.

(2) Common Law Temp cessation of production doctrine – There has been a temp cessation of production when a lease, though not producing, is one that a reasonable prudent operator would continue to hold. Thus, “temporary” is a question of fact. have a reasonable time to start producing again(i) Issue of fact (decide on case-by-case) Factors Ct’s will consider:

(a) The period over which the cessation extends – Duration is important but not controlling. (b) The cause of the termination – Courts are lenient where cessation results from circumstances

that may work to the benefit of the lessor as well as the lessee, such as efforts to improve or reinstate production or where the cessation is the result of accidents, application of government regulations, or other circumstances beyond the lessee’s control.

(c) Lessee’s efforts to restore production - Lessee’s diligence in working to regain production is an important factor in determining where cessation is temporary or permanent.

(ii) State ex rel. Com’rs v. Amoco (Okla. 1982)(a) Where cessation of production of oil and gas well was due to mechanical difficulty beyond

control of lessee, and lessee immediately and diligently drilled a second well to the same formation restoring production, lessee acted reasonably and diligently and oil and gas lease did not expire by its own terms.

(3) Dry hole provision: acts as constructive production assuming you comply with the rest of the provision. You still need to fulfill obligations of making delay rentals and commencing operations somewhere else. (i) Rogers v. Osborn- No actual production

(a) Drilling of and production from a second well commenced after the expiration of the primary term will not support the lease.

(b) Clause mentioning drilling and reworking refers to the first well not the 2nd (ii) Courts face these questions

(a) What is a dry hole? Well that is unsuccessful in that it does not satisfy the requirements of other provisions of the lease that require the drilling of a producing well.

(b) When is a dry hole complete? Not completed until the targeted formations are dilled to and tested.

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(c) When are rental payments due after a dry hole is drilled? Will permit a lessee that has drilled a dry hole to maintain the lease for the remainder of the primary term by payment of rentals.

(4) Operations clause – The effect of this is to make operations for drilling constructive production for purposes of the lease so that the lease will not expire at the end of the primary term if the lessee has started drilling operations, but has not yet completed the well. Gives the lessee the chance to complete what he has started. Assuming you comply with provision, lease will not terminate since there is constructive production to satisfy the habendum clause(i) “Operations” – Any substantial activity on the surface of the land that is directly related to securing

production, begun in good faith, and diligently pursued. Broad reading.(a) Well completion clause – to keep the lease alive, the well which was commenced before the

expiration of the primary term must be completed as a producer – not some other well (gives Lessee the right to finish the hole started, but not start another). This clause is more common than continuous operations clauses (And note that this is the clause included in our Burkhart form) 1 shot only…

(b) Continuous operation clause – so long as the first well drilled is commenced before the end of the primary term, you can drill as many dry holes as you wish and keep on trying so long as the hiatus between abandoning operations on one well and commencing operations on another does not exceed ___ days, and if you finally drill a producer, you have saved the lease.

d) Force Majeure Clause – Lessee tries to protect itself against unforeseen interference with operations. Applies to clauses designed to protect the parties against the possibility that the K cannot be performed due to causes outside the control of the parties and that could not be avoided by due care. (1) Perlman v. Pioneer Limited Partnership

(i) An actual, material hindrance must occur before performance is excused. The mere possibility or unsupported conclusions of the existence of hindrance is insufficient.

(ii) There is a duty to make a reasonable effort to remove the force majeure should one occur. (2) Courts usually construe such clauses strictly(3) Force majeure clauses are usually applicable to performance failures caused by:

(i) natural disasters (earthquakes, hurricanes, floods) (ii) wars, riots or other major upheaval (iii) performance failures of parties outside the control of the contracting party (e.g., disruptions in

telephone service attributable to the telephone company or labor actions by employees of a common carrier)

(4) Tracker Exploration- Intentional overproduction resulting in RRC action(i) Failure to comply with the RRC’s requirement, which resulting in the shut-in order (making them

stop producing to make up for overproducing before), was an event within the reasonable control of Lessee. Thus the order of the RCC could not be a event of force majeure sufficient to maintain the lease.

e) Shut-in Royalty Clause (Gas well only)– Common for a lessee to drill and complete a well capable of producing gas and then encounter difficulty or delay in marketing production from time to time. Permits the lessee to maintain the lease without marketing and provides for payments of shut-in royalty to the lessor. (1) Freeman v. Magnolia Petroleum

(i) If payment of the shut-in royalty is made a condition for continuance of the lease or failure to pay is made a special limitation, improper payment terminates the lease.

(ii) However, if the language creates a mere promise to pay, then the lease should not generally terminate if payment is not made, but the lessor should be able to recover the payments.

(iii) If the constructive production defined by the clause is the existence of a well on the premises capable of production in paying quantities, then the lease should not terminate at the end of the primary term even if the shut-in royalties are never paid.

(iv) If the language makes proper payment the constructive production, however, then if the payment is not made correctly the lease terminates because failure to have either actual or constructive production triggers the special limitation to the term of the lease.

(v) For a well to be maintained by the payment of shut-in royalties, it must be capable of producing gas in paying quantities.(a) Capable of Production in Paying Quantities – Means a well that will produce in paying

quantities if the well is turned “on” and it begins flowing, without additional equipment or repair.1. TX – very important to pay on time, or will terminate lease…

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Savings clause turns a limitation to a condition. Ie. After giving written notice, there is a period of time for you to cure it.

2. OK – is that shut in gas well is capable, then that capability will satisfy. Gard v. Kaiser(vi) When is it okay to use the shut-in gas royalty clause, and when isn’t it?

1. Ex. What if a lessee tries to employ the shut in royalty just to wait for a better market? We can get away with that in Oklahoma because we can extend a lease just by the capability of production from a well (as opposed to actual production). Kansas, on the other hand, says that shut in royalties can’t be used just to wait out the market.

f) Pooling Clause – Gives lessee the right to combine small tracts or fractional mineral interests for drilling on a spacing unit. Production or operations anywhere on a pooled unit is deemed constructive production for purposes of the lease.

(i) Conservation objective is to drill no more wells than necessary(ii) Lessee can still have more than on motive. (iii) If there is a pooled tract there is no implied covenant to prevent drainage.

g) Lease Pooling Clause: Pooling clause authorizes the lessee to pool the leased premises with other lands on both the lessor’s and lessee’s behalf.(1) Pooling provides that if there is production on either land, then it will be deemed constructive production

on the other land. It is a type of savings clause.(2) Pooling eliminates the covenant to prevent drainage. The pt of having an offset well is to get your fair

share. When you pool you get your portion.(3) Good faith use of the pooling power – all it requires is a valid conservation reason for doing the pooling(4) If the a portion of the lease is polled it saves the whole lease (under the habendem clause) unless you

have a Pugh Clause which says that only the portion included in the pooled unit will be saved by drilling within the unit.(i) Statutory Pugh Clause 52 O.S. 87.1(b)

(5) Amoco Production v. Underwood(i) Pooling arrangements must be made in good faith by the lessee. A pooling designation may not be

made to undercut the interests of the royalty owners. (ii) Duty of good faith here means that the lessee is not to purposefully include in a unit any interest

contrary to that of the lessor. What constitutes a breach of the duty of good faith is to be a matter for the trier of fact.

1. Pooling on the last day of the term might be evidence of lack of good faith but it is not conclusive.

2. A reasonable prudent operator would have no desire to keep a lease when he does not plan to drill on it.

3. No bad faith if you actually plan to drill on it.(6) Easier way to find bad faith is to find that someone puts unproductive land in the pool.(7) Kuntz, Law of O&G: A lessee is not a fiduciary and the standards that apply to fiduciaries are entirely

too strict. (Lessee has not undertaken to manage and develop the property for the sole benefit of the lessor). The lessee has substantial interest that must be taken into account, and he should not be required to subordinate the lessee’s own interests entirely to the interest of the lessor…(i) Okay to have a selfish motive, so long as the unit itself makes sense from a conservation standpoint.

(8) Conflicts between Units established by Pooling Clause: (i) Hladik v. Lee (Okl. 1975)

(a) Does the Corp Comm’s ordered spacing unit supersede the declared unit (voluntarily pooled unit) insofar as distribution of royalty upon gas produced from spaced formation through well on spacing unit?

(b) The intent of pooling clause was that any spacing unit established by the Corp Comm would, insofar as it covered same lands and formations, supersede a declared unit created pursuant to a pooling clause, at least in circumstances of the present case, where no production was had from declared unit prior to time order establishing spacing unit was issued.

h) Forced Pooling by OCC: 52 O.S. §87.1(e)(1) On a proper showing of evidence, an order from the Comm will provide for 1 of 2 options…

(i) Participate: A party will either elect to put up his share of the $ to drill/risk of the operation, or (ii) Not Participate: to accept some form of mineral compensation in lieu of participation…

(a) Ex. $150 per acre and yield up a part of your interest just as if you had leased the land (whatever the going rate may be). And if there is production, you would get your portion of a 3/16 royalty (whatever going rate is)

(2) Home-Stake Royalty v. OK Corp Com’n (OK 1979)

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(i) Compensation under option 2 above – expert witness testimony that highest price paid by corp seeking order pooling interests under same common source of supply was adequate evidence to establish that the same price was adequate compensation under forced pooling order

(3) Ward v. OK Corp Com’n(i) Non-drilling owners of a divided interest in a spacing unit is entitled to share in the production from

the unit well commencing on the date the Comm established the unit…no matter whether well was drilled before or after spacing unit was established.

(ii) Police power of the state extends to protecting the correlative rights of owners in a common source of O&G supply and this power may be lawfully exercise by regulating the drilling of wells into said common source of supply and distributing the production thereof among the owners of mineral rights in land overlying said common source of supply…

(4) Eason Oil Co. v. Howard Engineering(i) Corp Comm’s action to despace from 640 to 160 acres for future wells did not divest contractual

participants of their vested right to production from the existing well according to initial investment percentages under prior valid pooling order.

(ii) Is a working interest ownership in a producing well completed under Corp Comm spacing order altered when a subsequent order reduces the size of the drilling and spacing units for the same common source of supply… NO!

i) Oklahoma Corp Comm Jurisdiction:(a) OCC DOES have jurisdiction to “clarify” its own orders (if words or orders are ambiguous or

confusing)(b) Public rights / Private rights(c) Dist Cts have jurisdiction to determine the “legal effect” of a Comm order.

(2) Tenneco Oil Co v. El Paso Natural Gas Co. (Okla. 1984)(i) No attempt was made by either party to change or challenge the public issue of conservation of O&G

(Comm Order), all the items in dispute are private and part of the operating agreement and therefore were brought properly to the dist ct. instead of the OCC

(3) Nilsen v. Ports of Call Oil Co.(i) Nature of merit question to be decided – whether the operations constituted continous drilling

operations(ii) Jurisdictional issue – the question required interpretation of the pooling order and thus jurisdiction

was properly with the OCC, not the Dist. Ct.(4) Hadson Petroleum Corp v. Grynberg & Assoc

(i) Pooling order wherein the OK Corp Comm specifically reserved jurisdiction to determine reasonableness of well costs in the event of a subsequent dispute. Does the Corp Comm have exclusive jurisdiction to determine reasonable drilling costs?

(ii) Even under a pooling order which reserves to the Comm the jurisdiction to determine reasonableness of well costs, the Comm cannot have exclusive jurisdiction… The identity and of the party responsible party and reasonableness of costs are private concerns properly cognizable before the Dist Ct.

IX) Covenants Implied in the Oil and Gas Lease – a) Oil and Gas Implied Covenants

(1) To drill an exploratory well(i) Only of historical relevance since now we have delay rental payments

(2) To protect the leased premises from drainage(3) To reasonably develop

(i) By drilling an adequate number of wells within a reasonable time to formations known to be producing on the leased premises or the immediate vicinity of the leased premises

(4) To explore further(i) Idea is that eventually an exploratory well would be drilled to formations not known to be producing.

Not followed in OK, TX. Yes in CO.(5) To market (i) within a reasonable time and (ii) at a reasonable price(6) To operate diligently and properly

(i) Use modern drilling and production techniques(ii) Duty not to prematurely abandon the property

b) Nature and Classification of Covenants (1) Brewster v. Lanyon Zinc Co. – Covenant is contractual.

(i) Wanted to terminate the lease because lessee had failed to reasonably develop the property.

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(ii) Reasonably prudent operator – look to see what other people in the industry would do to see if there is a breach of an implied covenant.

1. Fiduciary standard – Some states use this and hold lessee to standard of fiduciary. A lower standard than RPO. To exercise the utmost good faith toward the lessor.

(iii) Covenant implied by fact - Covenant is implied because of the intention of the parties. Means you can draft around it in the lease. Texas considers all implied by fact.

1. Can’t negate them all with a provision saying there are no implied covenants. Held by TX SC to be unconscionable.

(iv) Covenant implied by the law – Covenant implied because of the relationship between the parties. Makes it fair and equitable to have a certain covenant. You cannot draft around this because it is a legal obligation. TX does not adopt this view.

(v) Remedy – (a) Majority View – cancellation may be sought as a remedy for breach of implied covenants only

upon a showing that damages are wholly inadequate(b) Minority – exclusive remedy is damages

2. Implied Covenant to Protect Against Drainage – The lessor grants a lease to the leassee to transfer the right to search for, develop, and produce oil and gas from the property, but neither the lessor nor the lessee contemplate that operations on other property may cause the oil and gas under the property to be drained away.

(1) Amoco Production Co v. Alexander [Problem w/ Common Lessee](i) The standard of care in testing the performance of implied covenants by lessees is that of a

reasonably prudent operator under the same or similar facts and circumstances. (a) Duties of a reasonably prudent operator may include:

1. Drilling replacement wells; Re-working existing wells; Drilling additional wells; Seeking field-wide regulatory action; Seeking R37 exceptions from the RR Commission; Seeking voluntary unionization; Seeking other available administrative relief.

2. No duty unless such an amt of oil can be recovered to equal cost of administrative expenses, drilling, or reworking and equipping a protection well, producing and marketing the oil, and yield to the lessee a reasonable expectation of profit.

(ii) RULE: A lessor is entitled to recover damages from a lessee for field-wide drainage upon proof: (a) of substantial drainage of the lessor’s land, and(b) that a reasonably prudent operator would have acted to prevent substantial drainage from the

lessor’s land.(iii) Implied covenant to protect against drainage is an action sounding in K and will not support recovery

of exemplary damages absent proof of an independent tort. (iv) In TX drainage cases, burden is on the lessor to prove that substantial damages had occurred and that

an offset well would produce oil or gas in paying quantities.

(2) Must make a demand for further drilling(i) Barnes v. Mack Oil Co.

(a) In order to sue for breach of the implied covenant to protect against drainage, the lessor must make a demand of lessee to drill additional wells to protect against the drainage he claims is occurring. Make the demand to give lessee notice of problem and give an opportunity to remedy.

(b) Some leases have notice and demand clause/notice-before-forfeiture clause(c) Some provisions called judicial-ascertainment clauses go even further by providing that the lease

may not be forfeited or declared terminated until the lessor has proved the breach complained of in a court and then, after judgment, the lessee has been given a reasonable time to comply.

(3) Must be able to make profit after drilling the offset well. (i) Sunray Mid-Continent Oil v. McDaniel

(a) Probable profitability means:1. The evidence must establish that the drilling of a protection well should probably produce

sufficient oil and/or gas to repay the cost of drilling, equipping and operating such well, and also return a reasonable profit on the entire outlay.

2. This is NOT like paying quantities – includes ALL costs and must make at least a reasonable profit

(ii) Indian Territory Illuminating Co. v. Rosamond (OK 1941)(a) The implied covenant to protect land from drainage, so long as drilling will, in the judgment of a

reasonably prudent operator, be a profitable undertaking, is a “continuing covenant,” the obligation resting upon the lessee during the existence of the lease or as long as his ownership continues.

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(b) The fact that part of a claim for breach of a continuing covenant is barred by statute of limitations, does not bar the other “good” portion of the claim. 1. Ex. If breach has been going on for 10 years but SOL is 5 yrs, then you recover for the last

5 yrs. (4) The problem of the common lessee (i.e. the party with the duty to protect the leased premises from

drainage also has an interest in the well next door that is doing the draining).(a) the basic rule: gotta show substantial drainage and probable profitability(b) question: Do we change that rule when there is a common lessee?

1. Strict view – Disregard the probable profitability rule – if there is any drainage then lessee is strictly liable.

2. Middle view - Keep probable profitability rule, but shift burden of proof to the lessee to show why the well would not be profitable.

3. Basic view – keep the probable profitability rule as normal. (TX and LA)(c) OK view: Feely v. Davis: again, uses the reasonably prudent operator standard to judge the

conduct of the lessee – further, does not shift burden away from the plaintiff 1. Freely: Allow the operator to put on evidence of acting as a reasonably prudent operator.

a. Does NOT shift the burden… keeps the same elements. b. Although burden is not shifted, a good atty for the lessee will put on evidence.

(5) Remedies – Damages from lost income. Lost royalties on the amount of oil that would have been produced had offset been drilled.

(a) N American Petroleum Co v. Knight (OK 1958)1. [F] P demanded a protection well, D agreed to commence, but failed to do so. P sought

damages of $25K. Alternative expert estimated at 10K… Jury awarded 10K.a. 2 ways to estimate damages:

i. “how much should the well have produced?” Estimation…ii. “How much was drained away?” Look to the thieving wells…

b. Ct found testimony from expert as to amount of damage resulting from breach of implied covenant was sufficient evidence upon which to base verdict not in excess of such amount.

(b) In Barnes and Indian Territory damages were measured by how much oil was drained away. Here the instruction asks how much would the protection well have produced (which will almost always be considerably more)1. Seems unresolved in OK b/c of contract b/w the cases

b) Implied Covenant to Drill(1) The Implied Covenant to Develop – Not triggered until the lease is propelled into the secondary term by

production or some substitute. (2) RULE: Once the lessee has drilled a well and the lease is held by “production” or some substitute, the

lessee must continue to develop as would a reasonable prudent operator under the circumstances.(i) Superior Oil Co. v. Devon Corp

(a) Because of the law’s abhorrence of forfeiture, an oil and gas lease will not be cancelled for breach of an implied covenant without the lessor having first given the lessee notice of the breach and demanding that the terms of the implied covenant be complied with within a reasonable time.

a. Lessee should be given an opportunity to commence further development within a reasonable time.

(b) Elements of a breach of the implied covenant to develop. Burden on Lessor.1. Probable Profitability – (recover all costs plus reasonable profit).2. Proof that the lessee has acted imprudently in failing to develop - A Reasonably prudent

operation would have, by now, drilled one or more development wells.(c) Remedies

1. Lost Royalty Rule – Awards the lessor the royalty that the lessor would have received had the lessee drilled development wells as a reasonable prudent operator.

2. Lost Interest Rule – Calculates the lessor’s damages as the interest that the lessor would have received had the lessor been paid royalty on the wells that the lessee should have drilled.

3. Future Credit Rule – Awards lessor the lost royalty, but then permits the lessee to claim a dollar for dollar credit, without interest, when (and if) the lessee produces the oil or gas.

4. Lessors usually ask for a cancellation or forfeiture. This is permitted on the theory that the lessee has shown intent to abandon the lease by its activity or on general equitable principles.

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c) The Implied Covenant to Explore Further(i) (highly criticized by some courts, especially the Oklahoma Supreme Court – neither OK nor TX

recognize this implied covenant)(a) Difference between covenant to further explore and covenant to further develop

1. further development only applies to the formation in which we have already found production.

2. The implied covenant to further explore applies to seeking out other formations. It’s far from being widely accepted, and Oklahoma and Texas have pretty much explicitly rejected it

(b) Kansas deals with this by statute: if you don’t explore the deeper zones on your lease, you probably loose the lease as to those zones.

d) The Implied Covenant to Market – Requires a lessee to market production within a reasonable time after discovery and at a reasonable price. The reasonable prudent operator, having taken the risk of drilling successfully, will seek to make a profit by marketing.

(1) Sale Within a Reasonable Time(i) Bristol v. Colorado Oil & Gas Corp (9.5 yrs was reasonable b/c no pipeline even though lessee acted

with due diligence the whole time)(a) The covenant to operate necessarily embraces a duty to market the production to the mutual

advantage of both parties. (b) Reasonable time is measured, in some degree at least, by the diligence with which the lessee

attempts to secure a market. (c) In determining whether the lease has been forfeited for breach of the covenant to market, equity

will “impose a rigid standard of good faith on the part of the lessee,” measured in each case not only by the lapse of time, but the diligence of the operator as well.

(ii) Usual remedy is damages, not cancellation. Esp. when lessee has ultimately succeeded in finding a market and does market the product.

(2) Sale at a Reasonable Price(i) Amoco Production Co v. First Baptist Church of Pyote

(a) There is an implied covenant to exercise good faith in the marketing of gas, and particularly so where the interests of the lessor and lessee are not identical. 1. There is a duty owed by the lessee to obtain the best price possible for the gas, a duty which

can arise either under a “market value” or a “proceeds” royalty clause.2. Good faith must be explored by consideration of the circumstances then existing to see if

more favorable terms could be obtained for the gas produced.(b) What others pay for the same gas from the same well under an annual price re-determination

clause is strong evidence of market value.(c) TX SC. Holding of this case should not be interpreted as an absolute duty to sell at a market

value. Failure to sell at mkt value might be evidence of a breach of good faith. Parties can draft a royalty provision any way they want absent unusual circumstances.1. The implied covenant to reasonable mkt O&G serves only to protect the lessor from the

lessee’s self dealing. Does not override the express terms. Only way implied covenant will come into play is when there is self-dealing.

(3) Implied Covenant to Operate Diligently and Properly(i) Baldwin v. Kubetz

(a) Implied covenant of diligent exploration and diligent operation of any producing well includes the promise of doing such incidental or subsidiary acts as may be reasonably necessary to accomplish the major purpose. 1. In this instance the procuring of the drilling permit through an easily obtained zoning

exception.(ii) Common complaints by lessor

1. lessee damages property2. lessee prematurely abandoned a well capable of producing profitably3. lessee has failed to use advanced production techniques4. lessee has failed to protect the lessor by seeking favorable administrative action.

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(iii) Catch-all - Since it is the broadest of the implied covenants, might be used if something does not fit in the other categories.

(4) Implied Covenant to Seek Admin Relief: Implied cov. To operate diligently and properly includes a duty to “seek administrative relif”(i) Sinclair Oil Co. v. Bishop:

(a) Here, there was drainage from the lessors land because all the producers around them were using wasteful practices. Thus, the lessee should have sought a ruling from the Corporation Commission that would prevent such wasteful practices and thus protect the lessors’ rights.

(ii) Spaeth v. Union Oil Co.(a) Filing a suit does not suspend duty to protect… lessee should have applied for permit to drill

offset wells

X) Royalty Payments – Fraction of production extracted from the ground. Royalty is one of the incidents of mineral ownership.a) Remedies for failure to pay Royalties

(1) Cannon v. Cassidy – lessor’s filed for cancellation of the lease, but court held that lease could not be cancelled b/c of failure to pay royalties even where that failure was a violation of the express terms of their lease b/c that remedy was not expressly provided for by the parties lease.

(2) OK has statute providing for interest on late payments of royalties(3) OK statute did not give production owners priority over interests perfected under the UCC

b) “Market Value” Royalty Problem(1) Under a long-term sale contract, is the market value the value at the time of the K or at the time the

oil/gas is actually sold? Piney Woods v. Shell Oil(i) Majority Rule (taken from Vela case in TX): market value means the vale at the time gas is extracted

and sold rather than when the applicable sale contract was made. Followed in TX, MS, KS, MT(ii) Minority rule (taken from Tara case in OK): market value is equivalent to the price assigned in the

sale contract, as long as that contract was made prudently and in good faith. Followed in OK, LA, and AR

c) Costs of Production and Costs Subsequent to Production Distinction(1) Royalty is free of cost of production – Lessee is cost-bearer. His job to discover, extracts, produce, and

market. (i) Garman v. Conoco Inc – Royalty owner IS responsible for his pro-rata share of the marketing costs.

(a) Traditional - TX and LA adopt the rule that nonoperating interests must bear their proportionate share of costs incurred after gas is severed at the wellhead. Production ends when it comes out of the ground.

(b) Minority – Marketable Product Rule Followed in OK and KS: The implied covenant to market obligates the lessee to incur those post-production costs necessary to place gas in a condition acceptable for market. Overriding royalty interest owners are not obligated to share in the post production expenses undertaken to transform raw gas into a marketable product. 1. Rule limited to post-production costs required to transform raw gas into a marketable

product. 2. Upon obtaining a marketable product, any additional costs incurred to enhance the value of

the gas, may be charged against nonworking interest owners. Burden on lessee to show that costs are reasonable. (mutual benefit…theory)

(ii) Piney Woods II:1. The “workback method”: If you are paying royalties based on market value at the well,

then you have to calculate what that price is, and often, the only market costs you have to work with are the prices provided for refined, processed, gas. Thus, you have to take that price, and work backwards through the costs of processing the gas, to eventually get back to what the price of the gas at the well head must have been.

(iii) Westerman (CO, like Garman – following same view in OK)(a) Garman left open the definition of marketability. Westerman answers

1. Fluid coming out of the well bore is not marketable until it is an state that meets interstate pipeline specifications

2. Location counts as well – transportation costs are costs to make marketable (and thus not deductible by lessee) b/c stuff is not marketable until it reaches a commercially viable marketplace.

(iv) Mittelstaedt v. Santa Fe Minerals (OK 1998)(a) Royalty interest under O&G lease may bear share post-production cost of transporting, blending,

compression and dehydration when:

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a. costs are reasonable, b. actual royalty revenues increase in proportion to cost assessed against royalty interest, c. costs are associated with transforming already marketable product into enhanced

product,d. and the lessee meets its burden of showing these facts.

(b)Seems inconsistent – Court now basically says that if we are moving the gas only a short distance, we call that “gathering” and all those costs will be charged to the lessee. Only if you are moving the gas a long way, then can part of the cost be charged to the lessor.

(v) Howell v. Texaco(a)Royalty owner has the right to be paid on the best price available(b)If Producer is self-dealing, the courts will carefully scrutinize the transactions on which royalty

pmts are calculated(c)Intra-company gas sale cannot be the basis for calculating royalty payments (d)Royalty owner is entitled to have their royalty price based on the prevailing market price or the

work-back method, whichever one results in the higher market value.

XI) Natural Gas Market Sharing Act – 52 O.S. §581.1-.10; 52 O.S. §540 – also revised and renumbered; Production Revenue Standards Act – 51 O.S. §570.1-.15….. SEE HANDOUTS1. Maxwell v. Samson Resources Co.

a) Heirs of property owner were owners of property entitled to proceeds from gas produced from well before and after order of heirship.

b) Supp pg. 189.

XII) Division Orders (not sure if this is supposed to be on the exam or not)1. Division order – order basically stating who is supposed to receive the proceeds from production

a) The whole point of a division order is that the lessees have gone to a lot of trouble and legal fees to determine who they owe money to and how much. They want the parties to sign the division order so that the lessess can get agreement on those points. If they have a division order, they can have some safety in paying according to its provisions. BASIC IDEA IS TO PROTECT THE PURCHASER OF PRODUCTION.

b) While the division order may act as a safe harbor for the purchaser, there still remains a remedy for someone who has been underpaid – they can go after someone who got overpaid, on the theory of unjust enrichment.

c) Gavenda v. Strata Energy, Inc.TX rule: division and transfer orders bind overpaid royalty owners until revoked – ripped off royalty owners can recover the overpaid royalties from the overpaid royalty owners

XIII) Titles and Conveyances: Interest in Oil and Gas - Conveyances must normally be by a writing that contains words of grant, identifies the parties to the transaction, adequately describes the property, and is properly executed.1. Distinction Between Mineral Interests and Royalty Interests

a) Judicial Construction of disputed language in a lease – 3 step process:(1) Determine if the language is ambiguous

(i) Always a question for the Judge (not jury)(2) IF ambiguous, apply cannons of construction

(i) Usually construe to convey the largest estate(ii) Usually construe against the party who drafted the instrument

(3) Consider extrinsic evidence(i) Get on stand and testify to what their intent was when the deed was signed

b) Nature of the Interests(1) Bodcaw Lumber Co. v. Goode

(i) You CAN sever the mineral estate from the surface estate and make them subject to conveyance or exception in grant.(a) Subject to limitations imposed by statutes or judicial decisions, Owner of severed mineral

interest has an implied right to use the surface and subsurface in any way that is reasonably necessary to accomplish exploration, development, and drilling for the minerals.

(2) McSweyn v. Musselshell County, Montana(i) TC considered a mineral interest more valuable than a royalty interest of the same fraction b/c a

mineral interest has more attributes than a royalty interest – (a) Attributes of a mineral interest

1. Right to explore and develop (right of surface ingress and egress)2. Right to grant an oil and gas lease3. Right to bonus money upon grant of oil and gas lease4. Right to delay rentals

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5. Right to royalties on production(b) A royalty owner ONLY has number 5.

Right Mineral Interest Non-participating royalty interestRight to explore for and produce the minerals – including ingress and egress to

Yes No

Right to grant O&G lease Yes NoRight to receive lease bonus Yes NoRight to receive delay rentals Yes NoRight to receive production royalties Yes Yes

(ii) However, the appellate court reversed. Royalty owner does not have to contribute to the costs to drill the well and produce oil – thus TC was wrong b/c a 2% royalty interest is more valuable than a 2% mineral interest b/c you don’t have to pay costs.

(3) NonParticipating Royalty Interests (i) A royalty carved out of the mineral estate which either entitles its owner to a stipulated percentage of

gross production or to a stated fraction of whatever royalty is reserved in and oil and gas lease on the land

(ii) Creating nonparticipating royalty interests(a) Express it as a certain percentage of gross production: a 2 ½ royalty of oil, gas, and other

minerals produced and saved from the land1. OR

(b) Express it as a certain percentage of whatever royalty is provided in an oil and gas lease covering the land

(4) Overriding Royalty – an interest carved out of the lessees interest in the lease(i) Could be granted to landman or geologist to compensate for services or could be retained by lessee

when assigning the interest(ii) Careful drafting is needed to be clear whether the fractional interest is payable out of the entire

production or only out of the interest in production owned by the lessee.(5) Bonus – the sum or amount paid for the execution of an oil and gas lease whether in cash or out of

production.

c) Creation of Mineral and Royalty Interests(1) What words create a mineral interest and what words create a royalty interest?

(i) Magic words:(a) Royalty Language: “oil, gas… produced and saved from [the land]…” are words indicative of

a royalty interest (if there is also the lack of “in and under” language and the lack of a right of ingress and egress).

(b) Mineral Interest: If a conveyance gives an interest in the oil and gas “in and under” the land, then it would more likely be construed as a conveyance of a mineral interest. 1. Note that in Oklahoma, you may want to be really explicit, and say “it is the intention of the

parties hereto to convey a royalty interest as distinguished from a mineral interest2. Something that may also be an indicator of a mineral interest would be a grant of a right of

ingress and egress – since NPRIs don’t have that right, what you are looking at is more likely to be a mineral interest

(c) Remember the mineral bug analogy (at least in TX) – if you have a mineral interest, and then strip away some of the “legs” you still have a mineral bug.

(d) Inconsistent language in cases we read often was construed as conveying a mineral interest but reserving some of the attributes associated with it such as receiving bonuses and delay rentals.1. French v. Chevron (TX) – conveyed a mineral interest but reserved all rights except right to

receive royalty.2. Anderson v. Mayberry (OK) – Court found that in giving up bonuses and rentals they

implied gave up the executive right to lease as well. NE case comes to opposite conclusion saying that you have to expressly give up each part of the bug.

2. Shared Ownership of Mineral Estatea) Concurrent Ownership / Cotenants

(1) Development by Co-tenants: Non-consenting cotenants, i.e. when one or more cotenants won’t consent to oil and gas development

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(i) Minority rule – Law v. Heck: you can’t compel an non-consenting cotenant to be part of an oil and gas lease; doing so would equate to forcing them to exchange their personal property for real property.(a) you must get consent of the co-tenant or else you will be found guilty of waste.

(ii) NET PROFIT VIEW: Majority rule (Prairie Oil): One cotenant wanting to lease to an oil company to come on the land and drill, the other cotenant doesn’t want them to and won’t grant a lease. They are not in a fiduciary relationship to one another, nor are they each other’s agents.(a) If the well comes up dry, then the drilling cotenant has to bear the cost on his own; he can’t turn

to the nonconsenting cotenants and ask them to pitch in on the costs. 1. Consenting Oil tenant…

a. Can come on the land and drill/etc… also can vest those rights with an oil company – in fact, lessee finds themselves as co-tenants as well b/c they are in the place of one tenant and each co-tenant has equal right to develop all the land

2. Non-consentinga. Drilling cotenant has to account to the non-consenting for their proportion of

production.b. Drilling cotenant has the right to recover all of the money from production until the

amount of money collected equals the expense of drilling the well… until money produced equals expenses, the Non-consenting gets nothing, after that point, must distribute.

3. If the drilling cotenant drills a dry hole, then they have to bear the cost of the dry hole, and can’t charge it to the non-consenting cotenants. The trick is the phrase “confer a benefit” – if the drilling cotenant could make a convincing showing that by drilling the dry hole, they learned about the geology of the area and that information pointed them to the site of the successful hole, then they can charge the costs to the non-consenter.

4. Prairie tells us how to account for costs to the nonconsenting cotenants. The costs of developing and operating the property are deducted from the gross proceeds, and once the well has paid off, then the nonconsenting owner’s proportion of production is due them.

(iii) If co-tenants execute different leases to different lessees(a) The lessees typically enter into a JOA, rather than going it alone(b) Accounting can be a problem if the different leases provide for different royalty amounts

1. TX – tract allocation methoda. Lessor is entitled to royalty only on sales by his or her own lessee and has no right to

benefit from the marketing decision of any other lessees that have contributed working interests to the well

2. OK – weighted average – Blanchard Casea. Each royalty owner was entitled to share in 1/8 of all the sales of production from a unit

well in the proportion that his or her acreage bore to the total acreage assigned to the well

(2) Partition of Mineral Interests(i) Mosley v. Hearell

(a) No requirement for showing of equitable grounds as a prerequisite to the exercise of the right to partition. Equitable rules apply in determining how the property is to be partitioned, one partition is granted, but equitable principles are not material in determining whether or not the right of partition may be exercised.

(b) If not provided against by K, cotenant should expect the other cotenant to exercise his statutory right to partition at will.

(c) Exceptions1. In some jurisdictions (OK is one), fraud and oppression may be pleaded and proved as an

affirmative defense to partition.2. When co-tenants agree not to partition (usually expressly)

(d) Elements of a statutory cause of action for partition1. Joint ownership – (Partition is uniformly avail to TIC. Other states may allow in other

types of estates)2. Possessory Interest – Owners of non-possessory interest in 3. the minerals, by themselves have no right to partition.4. Estates of equal dignity – P must have an estate of equal dignity to that of the D. Equal

quantity not required, but equal quality is. 5. Throughout the land

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(e) Most jurisdictions favor partition in kind, but where mineral interests are concerned, some jurisdictions hold that the only equitable method of partition is by sale since it is not possible to determine whether the valuable minerals are uniformly present throughout property.

b) Successive Ownership and Nonpossessory Interests(1) Life Estates and Remainders

(i) Welborn v. Tidewater: (a) If the estate in a piece of land has been divided into a life estate and a remainder, you need to get

a lease from both of them in order to conduct operations on the land. 1. If you didn’t get a lease from the life estate holder, then you are trespassing. 2. If you didn’t get a lease from the remainderman, you are committing waste.

(b) Treatment of payments – corpus or income? 1. Royalty Income – CL all royalty to corpus to benefit remainderman… interest income of

royalty income to LT2. Bonus - regarded as representative of the corpus of the estate, and was thus put into the

corpus; the income from it was paid to the life tenant, and the remainderman eventually got it as part of the corpus. a. Oklahoma treats bonus not as part of the corpus, but rather as rent.

3. Delay Rentals – like rent, and are payable to the life tenant.(c) UPIA5 contains proportions that are used to determine what proportion of royalties and whether

they will be put into corpus or determined to be interest1. In the absence of UPIA telling us something, we treat the royalties as part of the corpus, to

be invested. Now remember, though, the interest thrown off by that investment may be given to the life tenant (remember, life tenant gets interest, remainderman gets the corpus).

2. We have to have a trust for the latest UPIA to apply. 3. In most cases, a state’s basic method of allocation can be changed by clear instructions in

the controlling instrument.(d) Open Mine Doctrine (hard minerals)

a. Under the open mine doctrine, though, if a “mine” is in operation at the time of the creation of the life estate, then the life estate holder gets all the income from the mine (i.e. it doesn’t go to the corpus)

(2) Tenants for Years and Holders of Defeasible Fees(i) Kuntz says in 9.2 that a theory that would support the agricultural tenants right to get damages (if not

an injunction) would be that the mineral owners are to reasonably exercise their rights and not unreasonably injure the surface. Bear in mind which interest was created first.

1. If the mineral lease was first, then a subsequent surface lease would take subject to the mineral lease.

2. If the mineral lease came after the surface lease;a. In Oklahoma - Court allowed surface lessee to recover damages for crops damaged

(this case was before the surface damage act). b. TX – Court allowed oil and gas lessee to recover from surface lessee when surface

tenant prevented oil and gas lessee from drilling.(b) Holders of defeasible fees generally can make oil and gas leases without getting the consent of

the owner of the reversion. 1. O A for so long as it is used to operate an orphanage

a. A leases to XYZ… later, A stops operating the orphanage… b. XYZ’s lease is still valid

(3) Creditors(i) A lessee should seek either a subordination of the vendor’s rights or else a ratification of the lease by

the vendor along w/ a present grant of after-acquired rights.3. Terminable Interests

1. Garden variety: “for a period of 10 yrs from the date of this instrument, and as long thereafter as oil, gas, or other minerals are produced in paying quantities…”

i. Archer County v. Webb – TX: the language of the lease does not extend to the royalty deed. A savings clause in the lease cannot operate to save the interest created in the royalty deed.

ii. Fransen v. Eckhardt: Remember, that for an oil and gas lease, “production” can be satisfied by the capability of producing in paying quantities (At least in Oklahoma). However, for the purposes of a

5 Uniform Principle Interest ActPage 26 of 34

Terminable interest, “production” must involve the reduction of the oil and gas to possession and receipt of financial benefits from the production unless the terms of the lease state otherwise.

iii. To put it another way, someone wanting to extend the term of the terminable interest doesn’t get the benefit of the “capability” concept, nor do they get the benefit of the shut-in royalty clause unless specifically provided otherwise.

iv. The lesson to be learned is that when you are creating a terminable interest, you have to remember you don’t get the benefit of a lot of the common law doctrines, so if you DO want to take advantage of them, you have to explicitly include them in your instrument.

v. Also note that an oil and gas lease executed by the terminable interest owner will terminate when the terminable interest terminates, absent some express language in the deed (by which the terminable interest owner got their interest) that allows the terminable interest owner to encumber both their interest and the complimentary future interest.

vi. Ludwig v. William – went as far as refusing to apply the temporary cessation doctrine to save a terminable mineral interest. (Many commentators feel this is too harsh a result)

vii.RLM Petroleum v. Emmerich: The lessee derives his rights solely from the lessor, and can’t have anything beyond what the lessor has. Here, once the lessor’s interest in the land terminated, then so did the derived rights of the lessee. (Hart would have went the other way on this language)

4. The Executive Righta) Basically, its just who has the right to execute an oil and gas lease on the land. That will usually be the owner

of the mineral estate, but sometimes that right might be split or severed from fractional mineral interests.b) Mims v. Beall - TEXAS: has held that the person who has executive rights has duty of “utmost good faith”

to the others holding interests in the property.(1) Manges – Equated standard of utmost good faith with a fiduciary standard. This means they have a

fiduciary duty to the nonparticipating royalty owner.(i) HOWEVER, standard is not interpreted as normal fiduciary standard (sub fid’s interest to the interest

of the benef), it instead charges the fid w/ acquiring for the non-executive every benefit that he exacts for himself.

(ii) No self-dealing - Executive rights holder has a duty to manage the interest by obtaining the most royalty possible and is prohibited from self-dealing.

c) OKLAHOMA – not a fiduciary duty, however utmost good faith is higher than the usual standard of good faith.

5. Defining “Other Minerals”a) Moser v. United States – TEXAS

(1) Uranium is discovered under the land where the surface estate had been conveyed reserving all ‘oil, gas, and other mineral rights’

(2) Reed I and II – established surface destruction test- if the only customary way to extract the substance will destroy the surface, then that mineral is deemed to belong to the surface owner. (i) Court specifically rejects using ejusdem generic

(3) Court here Rejects Reed and sets out a NEW TEST:(i) What is the ordinary and natural meaning of the word mineral?(ii) When something is within the ordinary and natural meaning, and is thus a mineral, it doesn’t matter

how close it is to the surface. This is to promote certainty in land titles(4) Only applied prospectively from June 8, 1983.(5) If the substance gets itself into the mineral estate, not by express grant, but by use of the ‘other mineral’

language, then you are still liable for reasonable surface damage. Common law (and thus if in by express grant) would only require surface damages where the damage has been excessive.

b) OKLAHOMA – only those substances that are constituents of oil and gas are considered to be “other minerals” (using ejusden generic)

(i) TEST: is the substance a constituent or a component of oil or gas6. Ownership of Coalbed Methane Gas –

a) There is uncertainty of the Law(1) Amaco Production Co. (Sup. Ct.) – found that the most natural interpretation of “coal” as used in federal

acts did not encoumpas CMG.(2) Texas has ruled that coalbed steam gas is part of the coal – for whatever that is worth. (3) OK – no case on the subject.

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XIV) Conveyance of Fractional Interests 1. Overconveyance : The Duhig Rule

a) Duhig Situation: When at the time of the conveyance in question (A WARRANTY DEED):(1) A portion of the mineral estate is owned by a 3rd party b/c it has been reserved to him in a prior deed,

AND(2) The conveyance in question does not mention or reference the fact that an interest is owned by a 3rd party,

AND(3) The conveyance in question purports to reserve a portion of the mineral estate to the Grantor.

b) Duhig Rule: Then the 3rd party’s unmentioned mineral interest is taken out of what the Grantor purported to reserve to himself and the grantee gets what he was supposed to get to the extent that the grantor actually owned mineral interest to pass it to him. (1) See Hart’s statement of the Rule on the handout if questions.

c) Duhig Reasoning: (1) Two Step Reasoning of Duhig: Court assumes that

(i) Grantor was attempting to save the ½ interest that he did own to himself (ii) Court says grantor is estopped from claiming this interest b/c he has breached the warranty of title by

purporting to convey more than he actually owned.(2) One Step Reasoning of Duhig: Court assumes that

(i) When grantor purports to reserve ½ mineral interest he is referring to the half owned by the third party and is in fact not trying to save anything for himself

(3) Not clear if OK uses the 1 step or two step – ask Hart to be sure. I think they use the 2 Step – I know they at least come out with a result consistent w/Duhig and that Duhig only applies when we have a warranty deed. See notes for March 29th.

2. DEED EXERCISEa) Apt Words – in a deed you must use the correct words to make a reservation to the grantor

(1) ‘except an undivided one-half interest in and to the oil, gas, and other mineral underlying said lands is reserved by grantor.’ – This will reserve minerals to the grantor (usually even if it is in the wrong place – see Deed B)

(2) ‘Provided that there is hereby excepted from this grant an undivided one-half interest in and to the oil, gas, and other minerals underlying said lands which is owned by certain third parties’ – This properly excepts from conveyance a mineral interest already reserved to a 3rd party in a prior deed. (Put it in granting clause – See Deed E)

b) Where to put the language – the right place to put either lang is in the granting clause area and not right after the warranty clause b/c if you don’t use apt words and put it below the warranty clause then it will purport to convey the entire mineral estate and only except the ½ interest from the warranty of title. (See Deed A)

c) Boswell Energy Corp. v. Arrowhead Homes, Inc. (OK). (1) Holds that courts should look to the intent of the parties even if apt words are not used and lang is in

wrong place. (2) Hart feels this opinion takes the certainty out of land titles.

3. Proportionate Reduction Clause (the Lesser Interest Clause)(1) Texas Co v. Parks

(i) “Saving Clauses,” or proportionate reduction clauses, are designed to protect the lessee in the event the lessor owns a lesser interest in the land which he undertakes to convey.(a) RULE: Write the lease as if you own the whole thing and let the “lesser interest clause” work to

reduce the interest accordingly…(b) In this case however, there was nothing in the “lesser interest” clause to reduce… (this was a

screw up on the drafters part, but still won)…1. Ex. If X owns and undivided ¾ interest in mineral estate, executes a lease 2. purporting to cover the entire mineral fee, the proportionate reduction clause would reduce

X’s royalty to ¾ of the royalty amount stated in the lease (from 1/8 to 3/32).3. Hypo:

a. Jones – undivided ½ mineral interest. Burdened by a 1/16 nonparticipating royalty interest owned by Winn). The other ½ mineral interest is owned by Morales.

b. Jones leases to ABC providing for a 1/8 royalty. Morales also leases to ABC providing for a 1/8 royalty.

c. Morales lease provides for a 1/16th royalty (1/2 of 1/8)… lease provides for 1/8 and the lesser interest clause works against this and reduces by ½.

d. Jones will be left with nothing… Jones will bear the burden of the 1/16th nonparticipating royalty interest.

XV)Conveyances of Interests in Leased Land

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1. No increase of burden clause – Provision makes clear that transfers by lessor will not increase the lessee’s duties.2. Conveyances “Subject to” an Existing Lease – To protect the grantor against a claim of breach of warranty, the

conveyance is normally made subject to the outstanding lease; to assure the grantee of receiving his share of lease benefits, the clause may then go on to state that the deed “covers and includes” lease rentals and royalties. a) Hoffman v. Magnolia Petroleum (TX)

(1) Hoffman = owner of 320 acres leased to Oil Co. and then conveyed interest to P by deed. Deed conveyed 90 specific acres in the granting clause but then the ‘subject to’ clause said that it covers and includes ½ of all the royalty and rental payments due under the said lease. Ct said that petition stated a good COA without regard to the failure to allege any wells drilled on the lease were in the 90 acre tract b/c the subject to clause granted him an interest in the whole royalties under the 320 acre lease.

(2) The two-grant theory:(i) The theory is that the instrument then conveys two separate interests, one in the estate mentioned in

the granting clause, and the other in the fruits of the oil and gas lease. (ii) In Hoffman the discrepancy was in the geography covered, but the most controversial application is

in conveyances where a different quantum of interest seems to be conveyed in each clause.b) Another theory is to look at the document as a whole and decide which of the two fractions is more consistent

with what the lessor meant to convey. Keeping in mind that the second fraction in the, “subject to” clause is meant to cover the lessor’s ass so he does not breach warranties with the existing lessee. (i.e. convey something that cuts into the current lessee’s royalty or bonus or whatever….) (1) Heyen v. Hartnett - KS looks to the intent of the parties

(i) The mistake is made by multiplying the intended fraction by 1/8 based on the mistaken assumption that the grantor owns the 1/8 mineral interest instead of a possibility of reverter in the whole mineral interest owned and the present right to royalties and rents.

(ii) Thus, the Court rejects the two grant theory and will reform the instrument to correct the above mistake.

(2) Concord Oil v. Pennzoil – a Texas case with a plurality following the intent rule(a) Granting clause 1/96 mineral interest. In the same paragraph he indicated there was an existing

lease. Covers and includes 1/12 royalty and rental. (b) Ct reads the two clauses as consistent b/c granting clause is granting the present interest. At the

time the mineral estate was subject to a 1/8 lease. If you wanted to convey away 1/12 of the minerals then your granting clause should say 1/96. 1. So Ct must assume that 1/12 is the estate that is was intended to be conveyed.

c) OK has not really gotten into this at all so don’t know which way they would go

3. Non-Apportionment Doctrinea) Non apportionment rule: Unless counteracted by an entirety clause in a lease, you do not apportion royalties

b/w owners of a tract all included under one lease when each owns specific acres and not an undivided interest in the whole(1) Japhet v. McRae: Owner of fee simple interest decides to divide a parcel, selling some fraction and

retaining the rest, but all of the property is under one oil and gas lease. Say the oil company drills a well on the land that is still retained by the original owner. Then only that person gets the royalties – they don’t have to share it with the people who own the land that is now severed and is not where the oil well was located. (i) Note that in Oklahoma, we often do our drilling on spacing units, and in that case, the various owners

in severalty are apportioned part of the proceeds from the oil and gas operations(2) Contrast a Community lease: Say we have Blackacre, with Smith owning the north half, and Jones

owning the south half. Now here comes an oil company with a lease that describes all of Blackacre, and to which both Smith and Jones sign on. This is a community lease. Now, say the oil company comes in and drills a well on the Jones property. Rule says that there is a rebuttable presumption that you meant to share in the proceeds from the operations in proportion to each owners’ portion of the total land described in the lease.

4. Top Leasing – a) Where a landowner, while his property is still subject to an oil and gas lease, executes a second lease that

gives the new lessee possessory rights in the property upon the expiration of the existing lease. b) Problem with top leases is that they may violate the rule against perpetuities. To avoid this, fill out the lease

just as you would otherwise, but include the language: “This lease is granted on the lessor’s reversionary interest in the leased premises, and is hereby vested in interest, but is subject to a lease interest recorded in _______ and will become possessory only upon the expiration of that lease.

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(i) Practice pointer: if you are asked to create a top lease, be sure not to cloud the title of the bottom lessee, and write it in some way that doesn’t violate the rule against perpetuities (say that it vests in interest right now, but it doesn’t vest in possession until the bottom lease expires.

(2) Doctrine of Obstruction may extend the bottom lease, if the top lease is not written properly(3) How else to create a top lease that does not violate RAP -

(i) By simply conveying possibility of reverter. (ii) Also, On the top lease, says this top lease expires in a certain number of years. Ie. 1 yr after the end

of the term of the bottom lease.c) Rule against perpetuities – No interest is valid unless it must vest, if at all, within twenty-one years after the

death of some life or lives in being at the time of the creation of the interest.

XVI) Interference with Interests in Oil and Gasa) Trespass and Related Action

(1) Geophysical Trespass – when seismic operations create subterranean shockwaves (vibrations) that are recorded on the surface on a seismograph(i) Phillips v. Cowden – the owners who can give permission to do seismic activities is the mineral

interest owner. The surface owner is NOT the person who can give permission to do seismic testing. As a practical matter, you get permission from both, and you will try to settle surface damages with the surface owner.(a) Texas has a device called “waiving the tort and suing in assumpsit” by which the mineral

interest owner can waive the tort of trespass (which basically amounted to a misappropriation of the exploration right) and sues under an “implied” contract – the question then becomes what the explorer would have paid the landowner for the right to enter and conduct exploration.

(ii) Enron Oil v. Worth – a mineral owner may sever and assign the surface easement for the limited purpose of conducting geophysical exploration.(a) When a mineral estate is divided among more than own owner without reservation, the

undivided interest owners become tenants in common, and each may enter upon the premises for the purposes of exploring for oil and gas and thus each can grant a third party the right to explore without the consent of the other.

(iii) Kennedy v. General Geophysical Co.(a) Exploration company requested permission from mineral interest owner, did not get it, shoot the

land along the road adjoining owner’s land.(b) Where there is actual invasion of the premises of another by throwing of dirt, stone, or debris,

proof of negligence is unnecessary to recovery of damages.(c) Some courts hold that in the absence of an actual physical invasion of the premises, no recovery

can be had unless negligence is shown(2) Physical Trespass

(i) DRY HOLE - Notwithstanding the good faith of a person who has drilled on someone else’s land, they are still liable for the amount by which the drilling of a dry hole decreases the FMV of the mineral estate. Humble Oil v. Kishi

(ii) PRODUCER – (a) When a good faith trespasser’s well results in production, then the true owner of the property is

generally entitled to the recovery of the value of the oil and gas produced. However, if the trespasser is truly acting in good faith, then they are entitled to retain the costs of drilling the well to the extent that such costs conferred benefits upon the true owner.

(b) If they are acting in bad faith, then they don’t get to retain jack (this is a form of punative damages). 1. However, even if they are a bad faith trespasser, they don’t forfeit the ownership of the

equipment at the well site if it can be removed without injury to the well (they do have to leave the well intact).

(3) Even if the costs meet the reasonable test, they cannot be deducted if they were not incurred during the trespass. For example, if trespassing b/c stayed on after lease expired… cannot deduct costs incurred before lease expired.

(4) Statute of Limitations – usually they will begin running from the time of the trespass or conversion. (i) In the case of concealment (possible from directional drilling) the SOL may not commence running

until the rightful owners acquires info that causes him to make a reasonable inquiry.(ii) In the case of a producing well, the violation is continuing. Therefore the rightful owner could

recover damages for any period w/in the SOL for trespass or conversion so long as title to the underlying property has not been lost through adverse possession.

(5) Underground activity – does fracing amount to trespass?? TX SC first said yes but then withdrew opinion saying ‘we should not be understood to approve or disapprove of ct of appeals opinion on the subject.

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b) Slander of Title –(1) Slander of title in when you lack any reasonable basis for claiming title, yet you do anyway, and you

cause the true owner to lose out on opportunities because of your actions clouding his title. (2) Elements P must prove:

(a) publication by the defendant1. usually requires an affirmative act. However in Kidd it was provided by a failure to act

(failure to record)(b) falsity of the publication(c) malice

1. deliberate conduct without a reasonable cause, i.e. there was no reasonable basis for the defendant to believe that their title was good – no color of title

(d) financial damage- you actually lost a deal. (e) an estate or interest in the property slandered

(3) Note 1 - If you do not have a provision in your top lease that indicated that it is subject to an existing lease and does not take effect until it terminates then you might find yourself sued for slander of title because it might cloud the title.

c) Loss of Title(1) Adverse Possession – Very few cases. In order to get it you must be exploring and extracting

(a) If mineral interest has NOT been severed from surface, then adverse possession of the surface will serve to give title not only to the surface, but to the mineral estate as well.

(b) If the mineral interest has been severed from the surface, then adverse possession of the surface will NOT serve to grant title to the mineral estate 1. (mineral owners aren’t sleeping on their rights… they just think some new surface owner

moved in, for all they know) – it will only give title to the surface estate.a. Note: however, that if the minerals are partially severed, then adverse possession of the

surface may still serve to grant title to the unsevered mineral interest.2. So how do you ripen title to a severed mineral interest? Apparently by coming on the land,

completing a well, and producing it for fifteen years (Diederich v. Ware). Thus, actual production of the minerals is like surface occupation, so to speak, and will constitute adverse possession of the minerals.

(c) Production from a production unit, while in many respects it is treated like production from all land within a unit, doesn’t suffice for the purposes of adverse possession of a mineral estate if the well is not located on the mineral estate. Atlantic Richfield

(d) What is the areal extent of the mineral estate that has been adversely possessed? In Deiderich v. Ware, the court said that if the adverse possessor goes in under color of title, then the area described by the document giving color of title is the area of the adversely possessed estate. If, on the other hand, there is no color of title provided by a written instrument, then you look to the physical parameters of the tract, i.e. a fenced area or other boundary

a. Note that there is not very much authority out there regarding the areal extent of adverse mineral possession

b. One more thing: adverse possession will not be disturbed even if a conveyance (severance) has been made by the true owner after the adverse possession has begun but before the statute of limitations has run. Fadem v. Kimball

(e) Claimant’s receipt of royalties and payment of taxes was not sufficient to divest ownership from record owner through adverse possession – Cornelius v. Moody Bible

XVII) Contracts and Transfers By the Lessee1. Legal Requirements and Drafting Considerations

a) An oral agreement to assign a lease is going to run you into the statute of frauds b/c it is an assignment of an interest in land. (1) Look to property code. In writing, signed by assignor, and conveyance is deliberate.

b) No warranty. Assignor is not warranting since he likely did not get one in the lease with the landowner. c) Federal Law Requirements:

(1) Securities Act of 1933 – regulates the initial distribution of securities(2) Securities Act of 1934 – Rule 10b-5 grants investors a private right of action for misrepresentations or

omissions of a material fact, or fraud in connection w/the purchase or sale of a security.(3) Oil and gas company can be exposed under these two regulations in it is involved in any basic categories

of oil and gas securities which must be registered under the acts.(i) Stock, cert of interest, or cert of participation in any profit-sharing agreement

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(ii) Investment contracts (iii) Fractional undivided interest in oil, gas, or other mineral rights that are created for the intent of

public saled) State law requirements – blue-sky laws of each statee) Leases frequently contain language providing that if a specific geographic portion of the lease is assigned,

delay rentals are thereafter apportioned on a surface acreage basis among the parties to the assignment and failure to pay will only terminate as to those acres. (1) One party could contractually agree to pay delay rentals.

f) Items of tangible personal property other than fixtures are not deemed part of the leasehold estate and do not pass under an assignment unless the instrument so specifies.

2. Lease Assignmentsa) Assignor usually retains an interest, such as an overriding royalty, in the acreage or stratum trans.

(1) Unless there was some sort of fiduciary relationship between the overriding royalty interest owner and the assignor, then when the underlying lease dies, so does the royalty.

(2) Note that many of the implied covenants that we talked about do not extend to overriding royalty interests.

(3) Reynolds-Rexwinkle Oil, Inc v. Petex, Inc. (Extension of overriding royalty/ Washout Transaction)(i) RULE: when an assignment expressly provides that any extension or renewal of the lease shall be

subject to the overriding royalty therein agreed upon, the cts will regard a new lease procured by the assignee as an extension or renewal of the old one and charge it with the royalty so reserved…

(ii) Court considered three things:1. Terms of the two leases are substantially similar2. There’s a top lease by the same people who held the bottom lease that expired3. Most important: the overriding royalty contained extension and renewal language – “or

any extension or renewal thereof…” if you don’t have this language, then you really don’t have anything to argue about…

(4) Brannan v. Sohio(i) 10th circuit says that unless there is some special relationship in the transaction where the override

was reserved (some special fid like duty) then we are not going with the view that the override survived the washout.

(5) Cook v. El Paso Natural Gas(i) Hart says this case is wrong all over the place(ii) This is a common lessee situation – OK view is we don’t even change the burden of proof(iii) In OK – overriding royalty interest owner does not have the protection of the implied covenant to

prevent drainage.b) Most courts, unlike KS, will require proof of some sort of bad faith or at least some sort of special relationship

before they will let the prior override attach to the new toplease c) OK S.C. says that marketable product rule does not apply to the holder of an overriding interest.

XVIII) JOINT OPERATING AGREEMENTS1. See AAPL Model Form Operating Agreement2. Notes – 3 situations that lend themselves to parties entering into a JOA

XIX) Duties Owed by operator to non-operator parties:(1) Unit organization, with its operator, stands in a position similar to that of trustee for all who are interested

in the oil production either as lessees or royalty owners. This is NOT a fiduciary relationship in the normal sense. “Trustee-type relationship”

(a) West Edmond Huton Lime Unit (OK) (fieldwide unit)(b) Reserve Oil, Inc v. Dixson (OK-10th cir) (JOA – not pooled)

(2) Party given the responsibilities of the unit operator by OCC in a pooling order cannot re-delegate to anyone else his commission-conferred power to safeguard the correlative rights of the interest holders.

(a) Crest (OK)(3) An interest holder in a unitized parcel has the duty to conduct operations as a reasonably Prudent

operator, meaning that he has the right to protect against drainage(a) Sampson Resources v. Corp Commission

(4) There is a “fiduciary duty” owed by a unit to the royalty owners and lessees who are parties to the unitization agreement or subject to the order creating the drilling and spacing agreement. This isn’t a duty created by the lease relationship, but rather by the unitization order and agreement.

(a) Leck (OK)1. Hart thinks this case is out of mainstream by calling it a ‘fiduciary duty’ and that we can

conclude w/certainty that the operator of a unit well of a drilling and spacing unit owes a

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fiduciary-like duty to all persons entitled to share in production including royalty owners (your lessor and some other lessee’s lessor) and to the other parties entitled to share (the other lessees). Duty is to act as a prudent operator.

(5) Whether the SOL begins to run depending on whether the operator is a fiduciary b/c only if operator is a fid is it tooled b/c then they have a duty to tell you that there is production. Concurring opinion calls it a quasi-fiduciary duty.

(a) Goodall (OK)(6) Duty has to do with operations that directly bear on the unit itself (deal honestly w/$, etc.). Operator was

permitted to be clever and buy out future interest on a term lease w/out including other non-operator parties.

(a) ENI Producing Prop v. Sampson(7) There is not any type of duty for things that lay outside the scope of the operating unit like gathering pipe

system for many wells the operator had.(a) DeCordova (non-published)

XX)Mining Partnerships6

a) Nature of the mining partnership: parties don’t go out and say hey, let’s be a mining partnership. Rather, it is like a constructive trust in that it is just imposed on the parties by operation of law. It serves to impose joint and several liability on the members of the mining partnership for the expenses incurred by the operator.

b) Sparks Brothers Drilling Co. v. Texas Moran Exploration Co: 3 elements OK cts look for to establish a mining partnership (note: decide case-by-case)

(i) a joint interest in the property(ii) either an express or implied agreement to share in the profits and losses, and(iii) cooperation in the project

c) Remember that if a mining partnership is found, then the “mining partners” are jointly and severally liable for the costs incurred on the well. (1) K and H v. Ticina, 2002 Okla. 62 says that even if they are not mining partners, they are only personally

liable for their proportionate share of the expenses.(2) Non-operator party is personally liable to 3rd party creditors for their proportionate share of the operation

(ONLY liable for the whole thing – jointly and severally – IF found to be a mining partner)

XXI) Farmout Agreements(1) What is a farmout?

(i) Say that you are an oil company and you own a lease on Blackacre that is about to run out. Another oil company sees that you have those leases that haven’t been drilled on, and wants to drill them – asks if you would be willing to farm them out to them. A farmout gives the recipient the right to go out and drill a well, and if you do that, then the lease will be assigned to the recipient.

(2) Types of farmout agreements(i) Drill to earn: if the farmee goes out and timely drills the well, even if it is a dry hole, then he is

given the right to have the lease assigned to them.(ii) Drill to produce: same deal, but well drilled has to be a producer to get the assignment

1. Note - that the standard farmout agreement provides that there is no liability for failure to drill

(3) Oklahoma rule: farmee who breaches a contract to drill a well is liable for the reasonable cost of drilling the well to the specified depth – and note that it doesn’t matter what the farmor’s interest was. This means that if you breach on an expensive-to-drill well, you are gonna get stuck, big time.(i) No logical relationship between what it costs to drill a well and what one might have received had

the well been drilled and become a producer (OK rules defies logic)

(4) Three possible measures of damages for failure to drill a well:(i) Williams & Meyers: Damages Options :

1. OK rule: Cost of drillinga. Pro easy to prove (avoid reasonable certainty)b. Con $$$ you come up with bears little to no relationship to the damages suffered.

2. Value of the amount of production revenue that the promisee would have received had the promisor drilled the well.

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a. Need to clear the reasonable certainty hurdle as to whether the well would have been a producer, then have to come up with a reasonable estimate of production and pricei. PRO would be an accurate measure of the damages incurred by the promisee. ii. CON difficulty in proving with reasonable certainty (opposite of OK rule)

3. The value of the retained interest during the drilling but prior to the completion of the well as a dry hole. a. Accurate of damages if the promisee had intended to sell his interest in the well… if no

proof of this, simply a windfall to the promisee (Darcy)

XXII) Drilling Contracts1. When? O&G exploration company doesn’t own a lot of drilling rigs – when named operator, they have the staff to

manage and supervise, but will go to a drilling contactora) Three types of drilling contracts:

(1) Turnkey: Probably the least used type; only get paid one lump sum, and driller bears all the risk if the specified depth is not reached. As a result of this risk allocation, the price of this contract is liable to be much higher than the others.

(2) Footage basis: Most commonly used basis; driller gets specified amount of money per foot of depth drilled. (i) Driller takes risk of how the well proceeds (like if the drilling goes slowly. (ii) Typical footage contract has a “formations difficult or hazardous to drill” provision that says should

such formations be discovered, the contract will switch over to a day-work basis. (a) Another situation where the basis would change is when the operator asks the driller to stop

drilling and run a drill core test or some other activity that slows or stops the progress of drilling(3) Day rate: Driller will go 24/day for a specified amount per day, and operator is to be in charge (rate of

speed, type of mud used, etc. etc.)

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